South Africa holds rate, but remains in tightening cycle

    South Africa’s central bank maintained its benchmark repurchase rate at 5.5 percent, as expected, but said it remains in a tightening cycle and the pace of future tightening will depend on inflation, the economy and global developments.

     But the South African Reserve Bank (SARB) added that even if the policy rate is below what can be considered normal and is likely to rise in the medium term, this does not mean that there has to be a change in stance at every meeting and the size of the changes may not always be of the same magnitude.

    Gill Marcus, SARB governor, said monetary policy is still facing the dilemma of a subdued economic outlook amid persistent upside risks to inflation despite the recent appreciation of the rand, which remains vulnerable to shifts in global risk sentiment and adverse domestic developments.

    While SARB maintained its forecast for 2014 headline inflation to average 6.3 percent, with 6.6 percent in the fourth quarter, the forecast for average 2015 inflation was cut to 5.8 percent from a previous 6.0 percent, with inflation expected to average 5.6 percent in the final quarter of 2015 from 5.9 percent previously.

    The slight improvement in the inflation outlook is mainly due to the lagged effect of January's 50 basis point rate increase and inflation is still expected to breach the SARB’s upper end of its target range in the second quarter of this year before returning to the bank's 3.0 - 6.0 percent range in the second quarter of 2015 when it is expected to measure 5.9 percent.

    South Africa's headline inflation rose to 5.9 percent in February from January's 5.8 percent, but was down from a 2013-high of 6.4 percent in August.

     The outlook for core inflation has also improved, Marcus said, and expected to average 5.6 percent in both 2014 and 2015, compared with the previous forecast of 5.8 percent and 5.9 percent, respectively.

    “Notwithstanding this improvement, the upward pressures continue to be seen to be coming from the lagged effects of the exchange rate depreciation,” Marcus said, adding that the inflation risks remain to the upside as the exchange rate can overshoot for extended periods due to the current uncertain global environment and the current low level of inflation pass-through may not persist.

    The rand’s exchange rate has been volatile, but appreciated by about 2.4 percent against the U.S. dollar since the previous meeting of the SARB’s monetary policy committee, supported by improving risk sentiment towards emerging markets.

    The rand fell 19 percent against the U.S. dollar in 2013 as the Fed prepared to reduce its asset purchases and continued to fall until Jan. 29 this year, hitting 11.30 to the dollar. Since then it has appreciated and rose to 10.61 to the dollar after the SARB's decision.

     South Africa’s current account narrowed sharply to 5.1 percent of Gross Domestic Product in the fourth quarter from 6.8 percent in the third quarter for a 2013 deficit of 5.8 percent.

    “Although we expect the current account to respond to the depreciated exchange rate, this adjustment is likely to be gradual and some widening of the trade deficit is expected in the first quarter of 2014,” Marcus said, with the protracted strike in the platinum sector and relatively inelastic import demand constraining the improvement.

    Despite the continued tapering of asset purchases by the U.S. Federal Reserve, Marcus said the domestic yield curve had flattened – as the long end shifted downwards – and there was a net inflow to South Africa’s equity markets in February and March of 11.6 billion rand after net sales of 25.1 billion between November and January.

    Non-residents remained sellers of South African bonds but at a slower pace.

    But the outlook for South Africa’s economy remain subdued, with growth expected to remain below potential of 3.0-3.5 percent in 2014. SARB’s forecast for economic growth has been trimmed to 2.6 percent in 2014 from 2.8 percent and the 2015 forecast revised down to 3.1 percent from 3.3 percent previously.

    “The risks to this forecast are seen to be on the downside, given the protracted strike in the platinum sector and electricity supply constraints,” Marcus said.

    South Africa’s GDP rebounded in the fourth quarter of 2013 with annual growth rising to 2.0 percent from 1.7 percent in the third quarter when there was a strike-induced contraction in the manufacturing sector.

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