South Africa's central bank held its benchmark repurchase rate steady at 5.0 percent, as expected, and said that "given the increased upside risks to the outlook, we do not see room for further monetary accommodation."
The South African Reserve Bank (SARB), which has held its rate steady since July 2012, said the outlook for domestic growth remained fragile, with low business and consumer confidence and third quarter activity was expected to have been adversely affected by protracted work stoppages in the motor vehicle sector and this contributed to a decline in exports.
But the upside risks to inflation and a possible further deprecation of the South African Rand from a reduction in the U.S. Federal Reserve's asset purchases outweighs this weak outlook for growth.
"The upside risks to the inflation outlook remain elevated, dominated by uncertainties primarily relating to both the timing and the speed of the tapering of the US Fed's bond purchasing program me," said Gill Marcus, SARB governor.
SARB's forecast for growth this year and the following two years was revised down.
South Africa's inflation rate fell further to 5.5 percent in October, down from 6.0 percent in September and a 2013-high of 6.4 percent in August. Core inflation was steady at 5.3 percent.
While Marcus welcomed this decline, she said inflation was expected to remain "uncomfortably close" to the upper end of the central bank's 3-6 percent target band.
SARB's latest forecast for average 2013 inflation is 5.8 percent, down from the previous forecast of 5.9 percent, and inflation in 2014 is forecast to average 5.7 percent, down from 5.8 percent. For 2015 the forecast is unchanged at 5.4 percent.
"Inflation is expected to remain within the target range for the entire forecast period, with a peak of 5.9 percent in the second quarter of 2014," Marcus said.
But the forecast for core inflation in 2014 was raised to an average 5.6 percent from a previous 5.4 percent, with the "upward drift of the underlying inflation measure continues to be driven by the lagged effects of the depreciation of the rand exchange rate and the impact of higher unit labour costs," Marcus said.
Core inflation this year is forecasts at an unchanged 5.2 percent and 2015 an unchanged 5.3 percent.
Like many other emerging market currencies, the rand was hit hard by expectations that the Fed would start winding down its asset purchases in May, with the rand falling almost 10 percent against the U.S. dollar that month. Since then it has fluctuated around 10 rand to the dollar and rose to around 9.55 following the Fed's decision to delay tapering.
But it then eased to around 10.45 following the Fed's November meeting when financial markets expected an earlier start to tapering.
"More recently the rand has appreciated somewhat as the expected timing was pushed back by the markets, and also in response to the SARS release of new trade data," Marcus said.
The rand was quoted at 10.13 to the dollar today, following minutes from the Fed's November meeting on Wednesday that showed a reduction in asset purchases would be decided in "one of its next few meetings" if economic conditions warrant.
For the year, the rand is down 17 percent against the dollar.
"The exchange rate of the rand remains an increasingly upside risk to the inflation outlook, notwithstanding the relatively slow pass-through to consumer prices to date," Marcus said.
"The challenge facing the MPC is not only to anticipate the timing and speed of Fed tapering, but also to try to assess the extent to which tapering is already priced into the exchange rate. There is a risk that, should there be a stronger or more disorderly response by the markets to actual Fed tapering, the reaction of the exchange rate could be more extreme," she added.
South Africa's current account deficit also remains risk to the exchange rate and in the second quarter the deficit was 6.5 percent of Gross Domestic Product and Marcus said a further deterioration of the trade balance was expected following the temporary collapse of motor vehicle exports and significantly higher imports in the third quarter.
South Africa's economy also remains fragile, Marcus said, with third quarter growth expected to be weaker than in the second quarter and more in line with annualized growth of 0.9 percent seen in the first quarter. Weak third quarter growth is a consequence of protracted strikes that resulted in a 28 percent decline in the production of motor vehicles, parts and accessories.
The country's Gross Domestic Product rose by 3.0 percent in the
second quarter from the first for annual growth of 2.0 percent, slightly up
from 1.9 percent in the first quarter.
The central bank revised down its forecast for 2013 growth to 1.9 percent from a previous 2.0 percent, while the forecasts for 2014 and 2015 were revised down to 3.0 percent and 3.4 percent, respectively, from 3.3 percent and 3.6 percent.
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