The South African Reserve Bank (SARB), which cut rates by 50 basis points in 2012, painted a bleak picture, saying domestic growth prospects were fragile, consumer confidence was low, the mining sector was plagued by continuing disruptions, the supply of electricity was constrained and the global economic environment was weak.
"Given the current unsettled environment in the economy, the MPC assesses the risks to inflation to be on the upside, while many of the above factors contribute to a downside risk to growth," the SARB said in a statement following a meeting of its monetary policy committee.
South Africa's rand currency has been falling in value, down by some 4.6 percent against the U.S. dollar since late March and some 10 percent this year, as the confidence of investors since mid-2012 has been undermined by fraught labor relations and high wage demands, especially in the mining sector, and worries over a growing balance of payments deficit due to lower commodity prices and mining exports."The current level of the exchange rate, if sustained, poses a significant upside risk to the inflation outlook," the SARB said in a statement.
The impact of the weaker rand on inflation will depend on the extent and duration of the depreciation and while some of its decline reflects changes in fundamentals, the SARB warned the currency remains highly vulnerable to changes in sentiment and the current positive inflow of funds can quickly reverse.
"Despite the current negative sentiment towards the rand, non-residents have remained net buyers of bonds and equites this year," SARB said, buying 12.7 billion rand worth of stocks since January and 22.5 billion rands of bonds.
A decline in the rand helps the international competitiveness of South Africa's exporters, but the SARB said the competitive advantage of that needs to be realised through price and wage restraint, otherwise "the outcome is simply higher inflation with the risk of an exchange rate-inflation spiral."
The central bank cut its 2013 growth forecast to 2.4 percent from 2.7 percent and to 3.5 percent from 3.7 percent for 2014. In 2012 South Africa's Gross Domestic Product grew by 2.5 percent.
By 2015, SARB expects economic growth to accelerate to 3.8 percent, with the negative output gap starting to close that year after widening this year.
In the fourth quarter of 2012, South Africa's GDP expanded by 2.1 percent from the third quarter for annual growth of 2.5 percent, up from 2.3 percent.
South Africa's inflation rate was steady at 5.9 percent in April from March and February, but the SARB said food price inflation had risen by 6.3 percent in April, reversing a downward trend in place since November, and core inflation, which excludes food, rose to 5.2 percent from 5.1 percent.
The central bank trimmed its headline inflation forecast by 0.1 percentage points to an average of 5.8 percent this year and 5.2 percent in 2014 and an average of 5.0 percent in 2015 due to changes in assumptions about international commodity prices, including oil, and lower global inflation.
But inflation in the third quarter of this year is still expected to breach the SARB's upper end of its target range, hitting 6.1 percent, up from a previous forecast of 6.3 percent.
In 2012 inflation averaged 5.6 percent, in the upper end of the central bank's 3-6 percent target.
The forecast for core inflation, however, was raised to 5.3 percent from a previous 4.8 percent, due to higher medical insurance costs and higher administered prices and taxes.
A number of sectors in South Africa are entering into wage rounds and the SARB said it was concerned about settlements well above inflation and productivity growth, along with the risk of strikes that would cut into growth and exports.
"At a time of high and rising unemployment and slowing growth, the imperative of an economy-wide commitment to wage and salary restraint at all levels, including executive pay, cannot be over-emphasised," the central bank said.