South African Reserve Bank keeps rates on hold

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By Kevin Lings

The Reserve Bank decided today to leave the Repo rate unchanged at 11.0%. This was in line with market expectations. Only one or two analysts had expected a rate hike.

In deciding to leave rates unchanged the MPC made the following key points:

Economic conditions:

The international environment has become increasingly uncertain and volatile. The slowdown in global growth could have spillover effects on the South African economy which is also being affected adversely by electricity supply constraints.

Real retail sales have trended down since the middle of 2007. Sales of household furniture, appliances and equipment have contracted the most. Motor vehicle sales also continued their downward trend.

Credit extension to the private sector has moderated further.

Growth in household consumption expenditure is also expected to be dampened by negative wealth effects.

The risks to output growth appear to be on the downside and this is likely to be reinforced by the electricity supply disruptions.

Inflation risk:

The main upside risks to the inflation outlook remain food and energy price prospects, although the extent of the upside risk may have moderated somewhat.

The more favourable weather conditions and lower futures prices for maize have reinforced a general expectation of some moderation of food price inflation during the course of this year.

The threat posed to the inflation outlook by higher electricity prices remains. Eskom has been granted an average tariff increase of 14.2% from July. The precise increase that will be faced by households may be higher, and will only be known during the coming months. Furthermore, there is a risk that the increases granted to Eskom over the forecast period could be higher than currently anticipated. The average wage settlement for 2007 was 7.3% compared to 6.5% in 2006.

The rand exchange rate has depreciated in recent weeks following a period of relative stability. On a trade-weighted basis, the rand has depreciated by around 7% since the beginning of 2008.

Inflation forecast:

The most recent central forecast of the Bank indicates a further deterioration in the inflation outlook in the short term when compared to the previous forecast.

CPIX inflation is still expected to peak in the first quarter of 2008 but at an average of around 8,5 per cent.

In line with the previous forecast, CPIX inflation is then expected to decline to below the upper end of the target range by the final quarter of 2008 and to remain around the 5,6 per cent level for most of 2009.

The difficulty for the Reserve Bank is obvious: although both CPIX and PPI are well above 6% and likely to remain above 6% for most of 2008, a further hike in interest rates at this stage would do little to bring down specific high inflation items such as agricultural and food prices, especially considering that there is an international component to these high prices. At the same time there is no doubt that the consumer is hurting and that retail and motor sales are falling, while credit demand has clearly started to ease. The past rate hikes are working.

On balance, the decision today by the Reserve Bank to leave interest rates unchanged seems appropriate. This is especially the case when one considers the recent increased financial market turmoil in the international markets as well as the slowdown in world growth. This decision should allow the Reserve Bank to better assess the overall economic situation at their next interest rate meeting in April. We expect interest rates to remain on hold for most of 2008, with the possibility of an interest rate cut towards the end of the year, especially if food inflation moderates as expected.

Source: Kevin Lings, Stanlib, January 31, 2008.

OverSeas Radio Network

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