But the South African Reserve Bank (SARB) - which has now raised its rate by 175 basis points since January 2014 and 100 points in the last 12 months - also said that its core mandate is to contain inflation and the constraints facing the country's economic growth "are primarily of a structural nature and cannot be solved solely by monetary policy."
Three members of SARB's monetary policy committee voted for the 50-point rate hike while two members preferred a 25-point hike and one member preferred no change.
Financial markets had expected SARB to raise rates today, with most looking for a 50-point hike.
Despite the rate increase, SARB governor Lesetja Kganyago still considers the policy stance to be accommodative as the real rate is low given the outlook for inflation, which has deteriorated since the MPC's previous meeting in November due to the larger-than-expected depreciation of the rand and the impact on food prices from drought.
"Previously the Committee expressed concerns about the growth risks to the inflation outlook, mainly due to exchange rate and food price risks," Kganyago said, adding "these risks appear to be materializing and have contributed to the significant deterioration of the inflation forecast."
Inflation is now expected to average 6.8 percent this year and 7.0 percent in 2017, up from the previous forecasts of 6.0 and 5.8 percent, respectively. In 2015 inflation averaged 4.6 percent.
"Inflation is still expected to breach the upper end of the target in the first quarter of 2016, but is now expected to remain outside the target for the entire forecast period," Kganyago said, adding inflation is expected to peak at 7.8 percent in the fourth quarter of 2016 and the first quarter of 2017 before easing to 6.2 percent in the last quarter of 2017.
SARB, which targets inflation of 3.0 to 6.0 percent, said the impact on inflation from the lower exchange rate and higher food inflation more than offset the impact of lower oil prices.
The Rand has been on a weakening trend since mid-2011 when it was above 7 to the U.S. dollar. and fell by 25 percent against the U.S. dollar in 2015.
Since the Nov. 19 meeting of the MPC, the rand has depreciated by 13.5 percent against the dollar, with the depreciation exceeding that of most of its emerging market peers. Credit spreads and a rise in bond yields also point to a higher risk premium for South African assets.
In response to the SARB's rate hike, the rand firmed and was trading at 16.2 to the dollar, up from 16.4 yesterday, but still down 4.3 percent since the beginning of the year.
SARB also revised downward its outlook for economic growth, with growth in 2016 expected to average 0.9 percent, down from the previous forecast of 1.5 percent and 2015's estimated average growth of 1.3 percent. In 2017 growth is now seen rising to 1.6 percent, below the previous forecast for 2.1 percent.
The Reserve Bank of South Africa issued the following statement by its governor, Lesetja Kganyago:
"Since the previous meeting of the Monetary Policy Committee, the inflation outlook has deteriorated significantly, mainly due to exchange rate and food price developments. The rand has depreciated considerably in response to domestic and external developments, while the impact of the worsening drought on food prices is becoming increasingly evident. The outlook is complicated by the fact that the domestic growth outlook has weakened further. The global backdrop has also become more challenging particularly for emerging markets, and downside risks to the sustainability of the recovery in the advanced economies have increased.
The year-on-year inflation rate as measured by the consumer price index (CPI) for all urban areas measured 5,2 per cent in December, up from 4,8 per cent in November. This increase was broadly in line with market and the Bank’s expectations, and reflected in part the delayed response of food price inflation to the impact of the drought on agricultural prices. Food and non-alcoholic beverages inflation accelerated to 5,9 per cent, up from 4,8 per cent previously and contributed 0,9 percentage points to the overall CPI outcome. Goods price inflation increased to 4,6 per cent from 3,8 per cent previously mainly due to higher petrol and food prices, while services price inflation remained unchanged at 5,7 per cent. The Bank’s measure of core inflation, which excludes food, fuel and electricity, remained relatively stable at 5,2 per cent, up from 5,1 per cent in November.
Producer price inflation for final manufactured goods increased from 4,3 per cent in November to 4,8 per cent in December. The category of food, beverages and tobacco products contributed 2,1 percentage points to the December outcome.
The latest inflation forecast of the Bank shows a marked deterioration. Having averaged 4,6 per cent in 2015, inflation is now expected to average 6,8 per cent in 2016 and 7,0 per cent in 2017. This compares with the previous forecast of 6,0 per cent and 5,8 per cent for these years. Inflation is still expected to breach the upper end of the target in the first quarter of 2016, but is now expected to remain outside the target for the entire forecast period. A peak of 7,8 per cent is expected in the fourth quarter of 2016 and the first quarter of 2017, followed by a moderation to 6,2 per cent in the final quarter of that year (5,7 per cent previously). The changes in the forecast are mainly due to a significantly more depreciated real exchange rate assumption, and higher expected food price inflation. These upward revisions more than offset the impact of the lower international oil price assumption. The electricity price assumption remains unchanged from the previous meeting.
The forecast for core inflation has also deteriorated, although to a lesser degree than that for headline inflation. Core inflation is expected to breach the upper end of the target range for four consecutive quarters from the third quarter of 2016, with a peak of 6,4 per cent in the final quarter of 2016 and the first quarter of 2017. This measure is expected to average 6,0 per cent in 2016, and 5,9 per cent in 2017, and to moderate to 5,5 per cent by the final quarter of next year. The deterioration in the forecast is mainly due to the more depreciated exchange rate assumption and expected higher unit labour costs.
Inflation expectations as reflected in the survey conducted by the Bureau for Economic Research show a marginal upward movement for 2016 but a more pronounced deterioration for 2017, with average inflation expectations increasing from 5,9 per cent to 6,2 per cent, mainly due to the changes in expectations of trade union officials. Five-year inflation expectations edged up to 6,1 per cent, also mainly due to changes in the expectations of trade union officials. This survey was concluded prior to the depreciation of the rand in December, so the outcome of the next survey will be closely monitored.
The impact of the rand exchange rate weakness on market forecasts is evident in the changes to the Reuters Econometer survey between December and January. Median inflation expectations were stable in November and December, at 5,9 per cent and 5,8 per cent for 2016 and 2017, but increased in January to 6,0 per cent and 6,1 per cent. The median forecast for 2018 is 5,7 per cent. Break-even inflation rates also increased significantly across all maturities, with the 5-year maturities rising to current levels of around 7,3 per cent.
The global growth outlook appears to have worsened somewhat in recent weeks, contributing to a correction in global equity markets. Although most of the downward revisions to global growth have been due to the deteriorating prognosis for emerging markets, more recently the risks of a slowdown in the US have increased, amid declining consumer expenditure, and the impact of low oil prices and a strengthening dollar on business investment. However, despite the fourth quarter slowdown, growth of around trend is still generally expected. While the recovery in the euro area remains modest, the growth forecasts for the UK and Japan have generally been revised down.
Emerging market growth prospects, particularly for commodity-producing countries, remain constrained amid persistent capital outflows. The outlook is heavily influenced by the slowing Chinese economy but there are conflicting views as to whether a hard landing can be expected. There is also uncertainty regarding the efficacy of policy reforms that have been undertaken. Perceptions of the modifications to the renminbi exchange rate regime as well as equity market volatility have added to this uncertainty.
Global inflation pressures remain benign, reinforced by a further decline in international oil prices, but there have been upward revisions in some emerging markets. Monetary policies in most advanced economies are expected to remain accommodative. The slow pace of normalisation in the US is expected to continue, but further easing is expected in Japan and the euro area, while the Bank of England has indicated that monetary policy tightening is still some way off. Divergent monetary policy paths are also expected in the emerging markets. Commodity importers with sound macroeconomic fundamentals have scope for further easing, while some commodity producers, particularly those experiencing exchange rateinduced inflationary pressures, have been in a tightening mode, despite slowing growth.
The exchange rate of the rand depreciated markedly since the previous meeting of the MPC, contributing significantly to the deterioration in the inflation forecast. Since the previous meeting, the rand has depreciated by 13,5 per cent against the US dollar, by 15,2 per cent against the euro, and by 12,9 per cent on a trade-weighted basis. The muted reaction of the exchange rate to the start of US Fed normalisation suggested that this move was more or less priced in, but this was overshadowed by the impact of domestic developments on the exchange rate earlier in the month.
In early January, the rand reacted further to growing concerns about the outlook for the Chinese economy. While most emerging market currencies were affected, since the previous meeting of the MPC, the rand’s depreciation has been in excess of most of its emerging market peers. Other indicators such as widening credit spreads and the sharp increase in domestic bond yields point to a higher risk premium attached to South African assets.
Although at current levels the rand may appear to be undervalued, divergences from equilibrium can persist for some time. Furthermore, the current account adjustment remains slow, with the deficit expected to widen further in the face of continued weakness in commodity prices and higher drought-induced agricultural imports. The financing of the deficit will also be more challenging in an environment of persistent capital outflows from emerging markets. Since the previous meeting, non-residents have been net sellers of South African bonds and equities.
From a monetary policy perspective, a key risk to the inflation outlook is not only the possibility of further depreciation, but also the extent to which the there is a change in the pass-through dynamics, which have been relatively muted in recent years.
The domestic economic growth outlook remains weak, with further downward revisions to the Bank’s forecast. Growth in 2015 is estimated to have averaged around 1,3 per cent, and is expected to moderate to 0,9 per cent in 2016, before accelerating to 1,6 per cent in 2017. This compares with the previous forecast of 1,5 per cent and 2,1 per cent for 2016 and 2017. The Bank’s estimate of potential output growth was revised down from 1,9 per cent to 1,5 per cent for 2016, and from 2,1 per cent to 1,6 per cent for 2017. Although there was a marginal increase in the Bank’s leading business cycle indicator in November, the trend remains negative, consistent with the subdued outlook. The RMB/BER business confidence index declined further in the fourth quarter of 2015, to its lowest level in five years.
High frequency data indicate that the mining sector remains under pressure in the face of declining commodity prices and weak demand. Despite a recovery in the third quarter, the manufacturing sector outlook remains negative. Capacity utilisation has declined further and the Barclays PMI, which has remained well below the neutral level for some months, is consistent with a contraction in the fourth quarter. The continuing drought also means that near-term respite for the agricultural sector is unlikely.
Underlying this growth outlook is the continued low growth in gross fixed capital formation, with private sector investment contracting in the third quarter. The prospects for formal sector employment growth therefore remains bleak: the Quarterly Employment Statistics survey of Statistics South Africa reports static employment levels over the four quarters to the third quarter of 2015.
Growth in consumption expenditure by households also moderated in the third quarter, with contractions in spending on durable and non-durable goods. Domestic motor vehicle sales reflected this weakness although recent retail sales data, particularly with respect to semi-durable goods, suggest there may have been a modest improvement in the final quarter of last year. However, the decline in the FNB/BER consumer confidence index in the fourth quarter of 2015 to a fourteen year low suggests that household consumption expenditure is likely to remain constrained.
Credit extension to households has increased marginally recently, particularly with respect to mortgage and general loans. However, these increases remain low and negative in real terms, while instalment sale credit continues to slow. Tighter National Credit Act Regulations related to affordability assessments became effective from September, and are expected to constrain credit to households further. While credit extension to corporates remains robust, it is relatively narrow-based, and reflects in part increased demand for mortgage loans by property funds.
Wage and salary trends continue to contribute to the persistence of inflation at higher levels. Year-on-year growth in nominal salaries and wages, while lower in the third quarter of last year, was still above the upper end of the inflation target range. After adjusting for labour productivity increases, growth in total unit labour costs slowed marginally to 5,0 per cent in the third quarter. Andrew Levy Employment Publications reported an average wage settlement rate in collective bargaining agreements of 7,7 per cent in 2015.
Food prices remain a significant risk to the inflation outlook. The surge in agricultural commodity prices since early 2015 is beginning to impact on consumer food price inflation, and these pressures are likely to increase in the light of the persistent drought and the weaker exchange rate. This is despite continued moderation in global food prices. Although previous forecasts had incorporated an expectation of higher food price inflation, recent adverse developments have resulted in a further deterioration of the Bank’s food price forecast, which is now expected to peak at around 11 per cent in the fourth quarter of this year.
International oil prices have declined to multi-year lows since the previous MPC meeting. The global oversupply and consequent low prices are expected to persist in the short term, particularly following the lifting of sanctions against Iran. But with marginal producers expected to shut down or reduce production, prices are expected to follow a moderate upward trend over the forecast period. The impact of this upward trend on domestic petrol prices has contributed to the higher inflation forecast in 2017 in particular. The potentially favourable impact of the international oil price decline on domestic petrol prices has been more or less offset by the depreciation of the rand. Petrol prices have declined only marginally since November, and the current under-recovery suggests a possible increase of around 7 cents per litre in February.
Previously the Committee expressed concerns about the growing risks to the inflation outlook, mainly due to exchange rate and food price risks. These risks appear to be materialising and have contributed to the significant deterioration of the inflation forecast. The intensity of the drought has brought about a sizeable revision to the Bank’s food price outlook, while the exchange rate has depreciated significantly more than expected. While oil prices have a moderating impact on the inflation outlook in the near term, base effects and the assumed upward trajectory contribute to the adverse inflation outlook in 2017. The forecast also incorporates changes in administered prices, in particular for water, while an upside risk remains regarding electricity tariff increases.
The MPC assesses the risks to the inflation outlook to be relatively balanced. While there may be potential for further rand weakness in the short-term given the negative outlook for emerging markets in general as well as domestic factors, the lower observed exchange rate pass-through remains a mitigating factor. However, there is still uncertainty as to the sustainability of this low pass-through, particularly in the face of large nominal exchange rate movements as recently experienced. The upside risk from the exchange rate is more or less offset by the downside risks from the international oil price assumptions and projected food price inflation.
Demand pressures remain constrained, and the focus of the MPC will therefore be on the evolution of inflation expectations and indications of second-round effects of the exogenous shocks to the inflation outlook. There are some indications that inflation expectations may have deteriorated, but the extent of this will become more evident in the coming surveys. The trend in core inflation provides some indication of the possible emergence of second-round effects. Although core inflation has remained relatively contained in recent months, it is expected to accelerate and to exceed the upper end of the inflation target range for some time in response to exchange rate and wage pressures.
The Committee faced the continuing dilemma of a deteriorating inflation environment and a worsening growth outlook. The risks to the growth outlook are assessed to be on the downside, despite the downward revision to the forecast.
Given the deterioration in the inflation outlook, the MPC decided to increase the repurchase rate by 50 basis points to 6,75 per cent per annum, effective from 29 January 2016. Three members supported a 50 basis point increase, two members preferred a 25 basis point increase, while one member preferred no change.
The MPC still views the stance of monetary policy to be accommodative. Despite the rate increase, the real repurchase rate remains low given the higher expected inflation over the period. The MPC will remain focused on its core mandate of containing inflation within a flexible inflation targeting framework. As noted on a number of occasions in the past, the MPC is of the view that the growth constraints facing the economy are primarily of a structural nature and cannot be solved solely by monetary policy. Nevertheless, the MPC remains sensitive, to the extent possible, to the possible negative impact of monetary policy actions on cyclical growth. As before, future moves will be highly data dependent. "
NESBURG Jan 26 (Reuters) - South African bonds are still pricing in the first 50 basis point interest rate increase at a single meeting in two years this week, despite comments by the central bank governor suggesting he wants to keep to a path of gradual hikes.
At last week's World Economic Forum in Davos, Governor Lesetja Kganyago conceded that South Africa's inflation outlook had deteriorated due to a sharp fall in the rand, but said this was something the bank had expected, playing down the chances of a hike of more than 25 basis points.
At the two policy meetings when the bank lifted rates last year, it adjusted them by 0.25 percentage points each.
But analysts believe the balance of probabilities has shifted enough since the bank's November meeting to justify an increase of 50 basis points, a view reflected by market indicators.
Nineteen of 31 economists polled by Reuters last week saw a 50 basis point rise to 6.75 percent, with only 11 predicting a hike of 25 basis points.
Since then forward rate agreements show the money market is pricing in a nearly 70 percent chance of a 50 basis point rise in benchmark rates.
Kganyago will make the announcement from 1300 GMT on Thursday.
Yields on government-issued debt have drifted back up towards 10 percent after a brief relief rally pulled them slightly lower last week following a heavy sell-off.
"We believe the SARB (South African Reserve Bank) will wish to halt the weakening of the currency, otherwise capital outflows may increase, raising the probability of a financial crisis in South Africa," said London-based 4Cast EMEA analyst Rajiev Rajkumar.
The slide in bonds has mirrored a weaker rand, which has tumbled nearly 18 percent against the dollar in a rout triggered by the shock removal of the finance minister by President Jacob Zuma in early December.
Kganyago said last week the inflation outlook had deteriorated due to the rand depreciation, leaving the bank facing a policy dilemma of rising inflation and slow economic growth.
Investors will also scrutinise the bank's growth and inflation outlook in Thursday's statement for pointers on the interest rate trajectory for the rest of the year.
"It's not just the extent of the hike (this week). Whether you get 25 or 50 basis points hike will inform expectations about h
South Africa's economic outlook has been hit hard as falling demand from China becomes more apparent but a weak rand and high inflation will force the Reserve Bank to tighten policy aggressively next week, a Reuters poll found.
Nineteen of 31 economists said the central bank would raise interest rates by 50 basis points next Thursday to 6.75 percent while 11 said the Reserve Bank would raise by 25 basis points. Only one economist forecast rates unchanged.
"It is clear that the SARB will hike rates at the next meeting," said Elna Moolman at Macquarie. "The question is just whether the Bank will maintain the recent pace of 25 basis points increments or revert to the 50 basis points increments that used to be the norm."
If majority view is realized it would be the first time since July 2014 the Bank has added 50 basis points rather than the 25 basis point additions it has made since then.
Moolman predicted a 25 basis point hike but said the risk of a more aggressive move had clearly increased and may largely depend on data – particularly the rand and oil price – in the run-up to the meeting.
A weak rand has meant South Africa has not been able to fully benefit from tumbling oil prices and inflation is expected to average at 6.0 percent this year, touching the top-end of the Reserve Bank's comfort level.
ELEPHANT IN A CHINA SHOP
This month, economists slashed growth forecasts, with the median at 0.9 percent compared with December's 1.6 percent for this year's performance and gave a 50-50 chance the country would fall into recession this year.
"Chinese demand is slowing quite considerably, we are seeing that in commodity prices and that's obviously being exacerbated through a strong U.S. dollar. It's a continuation of that," said Jeffrey Schultz, at BNP Paribas in Johannesburg.
The rand has been heavily sold in the new year, touching a fresh record at 17.9950 per dollar earlier this month as investors fretted over China's weaker growth potential and the likelihood of rising interest rates in the United States.
Growth in China's economy slowed to the weakest since the financial crisis at the end of last year while a separate Reuters poll last week suggested the Fed would raise interest rates three times this year.
South African rates will end this year up at 7.25 percent, according to the poll, but even at that level some analysts said it won't be enough to halt the rand' s weakness.
"Currency weakness is the elephant in the room," said Mandla Maleka, economist at Eskom Treasury.
"Whilst we generally hope for exports to receive a lift through currency depreciation, this is a function of growth prospects from our trading partners."
dec 11 outh Africa's central bank will hold its monetary policy committee meeting in January as scheduled, a deputy governor said on Friday, despite the sharp depreciation of the rand currency following the removal of the finance minister.
PRETORIA, Nov 30 The depreciation in South Africa's rand currency has been an important contributor to inflation and is a major risk to consumer price forecasts, the central bank said on Monday, as the currency touched a record low.
The rand extended losses on those comments, having fallen earlier after the revenue agency reported a wider-than-expected trade deficit in October.
The South African Reserve Bank governor said no amount of intervention would stem market-driven rand moves.
"We've go to accept that a currency that moves because of changes in fundamentals, no amount of central bank intervention ... would stem that movement of the currency," Lesetja Kganyago told economists at a monetary policy forum.
In its twice-yearly monetary policy review, the bank said the exchange rate continues to exert inflationary pressure.
"Additional depreciation - which could be triggered by further falls in the prices of South African export commodities, or by (U.S. Federal Reserve) Fed (interest rate) lift-off - is the most significant risk to the inflation forecast," it said.
The rand, like other emerging market currencies, has weakened sharply against the dollar this year as investors anticipate that the Fed will start raising interest rates.
In its review, the bank said that the response to relatively low interest rates in Africa's most industrialised economy had been disappointing, while investment growth had been subdued.
The bank, which raised interest rates to 6.25 percent this month, reiterated that the priority for monetary policy was to keep inflation within a 3-6 percent target range.
Headline consumer inflation ticked up to 4.7 percent year-on-year in October compared with 4.6 percent in September.
The economic output gap remained negative and therefore monetary policy continued to be accommodative, the bank said.
"The real repo rate is still low in historical and comparative perspective, and somewhat below its estimated neutral level," it said.
Kganyago said he still expected the U.S. Federal Reserve to raise interest rates in December.
"Our baseline scenario is that we expect that the U.S. will lift rates in December," he said.
Even if U.S. non-farm payrolls data on Friday disappoint, the Fed is still expected to lift interest rates at its meeting on Dec.
Read more at Reutershttp://www.reuters.com/article/2015/11/30/safrica-cenbank-idUSL8N13P43H20151130#BkBr17ilsq5Kv7LA.99