The South African Reserve Bank’s monetary policy committee (MPC) has decided to keep rates unchanged at 3.5% per year, although two members preferred a 25 basis-point cut, while three preferred to hold rates at the current level.
This decision was taken against the backdrop of the slow economic recovery that will help keep inflation below the midpoint of the target range for this year and the next. “Unless risks outlined earlier materialise, inflation is expected to be well contained in 2021, before rising to around the midpoint in 2022 and 2023,” said Lesetja Kganyago, SARB governor.
However, consumers can steel themselves for projected increases of 25 basis points in the second and third quarters of 2021.
The effects of Covid-19
Kganyago said although Covid-19 would continue in new waves, the rollout of vaccines was expected to boost global growth prospects generally. Global growth for 2021 was therefore revised higher, but as global vaccine distribution was likely to be slow, it would create an uneven pace of global economic recovery in 2021.
The International Monetary Fund (IMF) had forecast global gross domestic product (GDP) to contract by about 4.4% in 2020 and to expand by 5.2% in 2021.
Economic growth forecast
In the third quarter of 2020, the South African economy grew by 66.1% quarter-on-quarter, seasonally adjusted and annualised, compared to the Reserve Bank’s expected 50.3% growth.
“The growth rate for the full year is now expected to be -7.1%, compared to the contraction of 8.0% expected at the time of the November meeting. However, our projection for the fourth quarter of 2020 is expected to be lower than previously forecast,” Kganyago said.
While current lockdown restrictions were considerably less restrictive, growth in the first quarter of 2021 was expected to remain muted.
Pre-pandemic output levels
Kganyago said despite very robust terms of trade and stronger exports, getting back to pre-pandemic output levels would take time. “Sharply lower public and private investment last year and continued weakness in 2021 will weigh on growth prospects. GDP is now expected to grow by 3.6% in 2021 and by 2.4% in 2022. GDP growth of 2.5% is expected in 2023.”
Risks to domestic growth
Risks to the domestic growth outlook were assessed to be balanced, he said. Global growth, vaccine distribution, a low cost of capital and high commodity prices supported growth but new waves of the Covid-19 virus were likely to periodically weigh on economic activity both globally and locally.
Kganyago also emphasised that constraints to the domestic supply of energy, weak investment and uncertainty about vaccine rollout remained serious downside risks to domestic growth.
Recovery in financial markets
According to Kganyago, accommodative policies in many advanced economies and the improved economic outlook continued to support recovery in global financial markets and some strengthening in international capital flows.
“So far this has resulted in a trickle of fresh MPC statement 21 January 2021 capital flows to South Africa, and financing conditions remain uncertain as reflected in the exceptionally steep yield curve.”
These favourable global conditions saw the rand appreciate by 1.7% since the November meeting, but since January 2020, the rand had depreciated by 8.0% against the US. dollar and remained below its estimated long-run equilibrium value. The implied starting point for the rand forecast was R15.70 to the US dollar, compared with R16.50 at the time of the previous meeting.
Headline consumer price inflation averaged 3.3% in 2020, in line with the Reserve Bank’s expectation, the lowest rate since 2004. Kganyago said the SARB’s forecast for 2021 was slightly higher, at 4.0% (up from 3.9%), 4.5% (up from 4.4%) for 2022 and 4.6% for 2023.
Core inflation averaged 3.3% in 2020, while the forecasts for 2021 (3.4%) and 2022 (4.0%) were unchanged. Core inflation was expected to be 4.3% in 2023.
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Global producer price inflation, food price inflation and oil prices have risen and a more appreciated nominal exchange rate in recent months is expected to moderate some inflationary pressure.
Kganyago said the overall risks to the inflation outlook appeared to be balanced in the near and medium term. Local food price inflation was higher, but expected to remain broadly contained. There was also the significant, but likely temporary, reduction in medical insurance price inflation this year.
“Given low pass-through, risks to inflation from currency depreciation are expected to stay muted. However, additional exchange rate pressures could result from fiscal risks. While there are no demand side pressures evident, electricity and other administered prices remain serious concerns.”
He pointed out that expectations of future inflation appeared more stable after sustained moderation last year, although those of households continued to moderate from quite high levels. Market-based expectations for short- and medium-term inflation had eased slightly, while longer-term inflation expectations remained higher.
Role of monetary policy
According to Kganyago, monetary policy had eased financial conditions and improved the resilience of households and businesses to the economic implications of Covid-19 and continues to be accommodative, as the SARB’s steps had ensured adequate liquidity in domestic markets. In addition, regulatory relief provided to banks had sustained lending to households and businesses.
“While monetary policy will continue to support the economic recovery, a faster growth rate depends on implementing prudent macroeconomic policies and structural reforms. Lower administered prices and productivity-adjusted wage settings aligned to projected inflation would also generate important macroeconomic gains. Such steps will enhance the effectiveness of monetary policy and its transmission to the broader economy.”
Kganyago warned that economic and financial conditions were expected to remain volatile for the foreseeable future. “In this highly uncertain environment, policy decisions will continue to be data dependent and sensitive to the balance of risks to the outlook.”