South Africa: Bank Cites Weak Rand as Rates Stay on Hold

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Business Day (Johannesburg)

10 October 2008
Posted to the web 10 October 2008

Mariam Isa
Johannesburg

THE Reserve Bank held interest rates steady yesterday, as expected, saying the outlook for inflation had improved but warning that the rand's sharp depreciation posed a threat.

SA did not need to join a round of rate cuts by central banks globally as its financial system remained stable in the face of global turmoil, said Bank governor Tito Mboweni. But he pointed out that local shares and the rand had been hit hard by global risk aversion, and the Bank was "monitoring developments closely".

"The monetary policy committee (MPC) considered recent developments in the South African economy and the risks to the inflation outlook against the backdrop of conditions prevailing in the international financial markets," he said.

"The MPC is of the view that an unchanged monetary policy stance is appropriate at this stage." Interest rate cuts had not even been considered at the two-day policy meeting, he told reporters later.

The Bank's decision to keep rates steady was not a surprise, but disappointed local markets.

Consumer spending has slowed sharply in response to the Bank's decision to raise interest rates by five percentage points since June 2006.

That has curbed economic growth, which now also faces the challenge of falling prices for its main commodity exports and waning global demand.

Business Unity SA (Busa), the country's largest business grouping, said it believed the Bank had made the right decision although it wanted to see a drop as soon as possible.

"Given the global economic crisis, the Bank is understandably waiting until a clearer economic and inflation picture emerges in the months ahead."

Government bonds weakened and money markets moved to price in a reduced chance of a rate cut by the end of this year.

Analysts described the MPC statement as "balanced" - weighing the risks to economic growth against inflation, which rose by a record 13,6% in August.

"The inflation outlook remains uncertain, as the risk profile has changed somewhat," the Bank said. "The outlook has improved on account of lower oil prices but the exchange rate has emerged as a significant risk.

The rand fell to a near seven-year low at R9,45/$ this week, hammered by risk aversion stemming from the global financial crisis. It has since clawed back some losses, trading at R9,08/$ late yesterday after briefly firming to R8,95/$1 on the Bank's announcement.

The decision not to cut rates should enhance the yield appeal of local assets to foreign investors, which in turn is likely to support the rand.

But the unit has depreciated 20% against a trade-weighted basket of currencies this year, which will raise the cost of imports and fan inflation.

Mboweni said the trend would offset a sharp fall in the price of crude oil, which is about $83 a barrel compared with a record $145 in July.

The effect of the exchange rate on inflation would depend on whether its new levels were sustained, he said. But the Bank's most recent central forecast showed a "moderate improvement" in the inflation outlook since the last MPC meeting in August.

Inflation measured by the annual rise in CPIX was now expected to peak at 13,3% in the third quarter of this year, up from a previous 13% forecast.

The Bank said it would average 6,9% next year, below its forecast of 7,2% in August. The price gauge, which excludes mortgage costs, has breached its 3%-6% official target since April last year. The Bank stuck to its view that inflation would not return to its target range until the second quarter of 2010.

Mboweni said the Bank's forecasts for a fall in inflation were in line with estimates from analysts, which range between two and three percentage points. "We are probably not far off from the private sector," he said.

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