The South African Reserve Bank (SARB), which is facing the uncomfortable combination of rising inflation and slowing growth, said that at this stage "a sustained breach of the inflation target is not our central forecast. However, we are concerned about the revised higher trajectory of core inflation and macroeconomic vulnerabilities that are increasingly evident."
Gill Marcus, governor of SARB, said the bank's policy committee was mindful of these conflicting pressures and its policy would be "highly dependent on how we see the inflation trajectory unfolding in this very uncertain environment. In other words, it has become even more data dependent."
SARB revised its growth forecast downward and its inflation forecast upward.
SARB, which targets inflation of 3.0-6.0 percent, said the outlook for inflation had deteriorated since May and it now expects average inflation of 5.9 percent this year, up from a previous forecast of 5.8 percent, 5.5 percent in 2014, up from 5.2 percent, and 5.2 percent in 2015, up from 5.0 percent.
"The deterioration is mainly due to continued currency weakness and higher-than-expected petrol price increases," SARB said, adding that inflation is expected to breach the upper end of its target in the third quarter of this year - an average level of 6.3 percent from 6.1 percent - but then return to the target range by the fourth quarter of this year.
South Africa's headline inflation rate eased to 5.6 percent inflation in May from 5.9 percent in April, March and February, but SARB said this was likely a temporary decline as a 73 cent cut in petrol prices in May had been reversed by an 84 cent increase in July.
The central bank's policy committee again revised its 2013 growth forecast down to 2.0 percent this year, from a 2.4 percent forecast, and to 3.3 percent in 2014 from a previous forecast of 3.5 percent.
"The downside risk to growth has already resulted in the Bank being more tolerant of inflation at the upper end of the target range than would normally have been the case, an approach that is consistent with a flexible inflation targeting framework," Marcus said.
Economic growth is expected to improve in 2015, with the economy expanding by 3.6 percent, down from a previous forecast of 3.8 percent. In 2012 South Africa's Gross Domestic Product grew by 2.5 percent and SARB last cut its policy rate by 50 basis points in July 2012.
"The risks to the outlook are still assessed to be on the downside, particularly in the face of further delays in overcoming electricity supply constraints," Marcus said.
South Africa's economy lost steam in the first three months of this year, with GDP expanding by only 0.9 percent from the previous quarter, the lowest quarterly growth rate in almost four years. On an annual basis, GDP expanded by 1.9 percent, down from 2.5 percent in the fourth quarter.
But SARB's ability to boost growth is limited by inflation and Marcus said the main risk to the inflation outlook comes from exchange rates and "much will depend on the strength of the pass-through to inflation, which to date has been relatively muted."
"However, the risk remain that these pressures could be mounting, particularly if further currency weakness occurs and affects inflation expectations, which are currently anchored at the upper end of the target range," she said, adding that the outcome of the present round of wage talks will be critical in determining how much wage pressure would impact the inflation outlook.
South Africa's rand has been under pressure since mid-2012 when labour unrest and high wage demands in the mining sector started to undermine the confidence of investors. The rand was also caught up in the general fall in emerging market currencies in May in response to fears of a tightening of U.S. monetary policy.
Since May, the volatility of the rand's exchange rate has increased, trading between 10.36 and 9.60 to the U.S. dollar, and since the start of the year it has declined by 14.2 percent agains the dollar.
Marcus said the relatively muted pass-through to inflation of the depreciation in the rand was likely due to weak pricing power as economic growth is low.