Johannesburg - Monetary policymakers in South Africa face the prospect of a prolonged breach of the inflation target, even as growth is slowing, the Reserve Bank said.
The main reasons for the elevated inflation forecast 'are the direct and indirect effects of both higher food prices and exchange-rate depreciation,' the South African Reserve Bank (Sarb) said in a report released on Monday in Pretoria. 'Inflation expectations over the long run are at or above the top end of the inflation target range.'
The rand lost 25% against the dollar last year, adding to pressure on inflation already fuelled by high energy costs and the worst drought in more than a century that’s pushing up food prices. Consumer inflation accelerated to 7% in February and the Reserve Bank forecasts it will only return to its 3% to 6% target band in the final quarter of 2017.
“Monetary policy can accommodate temporary shocks that cause target breaches, but should respond if those shocks risk leaving inflation permanently higher,” Sarb said. “The bank will deliver on its mandate” of price stability, it said.
The rand weakened 0.3% to R14.8290/$ as of 8:06 in Johannesburg on Tuesday, and was trading at R14.9 just before 10:00.
The monetary policy committee (MPC) has raised the benchmark rate four times since July to 7%, even as it cut its economic growth forecast for the year to 0.8%, which will be the slowest pace since 2009. While the rate of expansion will probably remain low despite the more competitive exchange rate, South Africa is likely to avoid a second recession in seven years, the Reserve Bank said.
'Over the long run, South Africa’s growth interests are best-served by keeping inflation within the target, not by looking to exploit a temporary trade-off between growth and inflation,' it said. 'Tolerating additional inflation in the short run could require larger interest-rate adjustments later, with proportionally greater costs to the economy.'
The current-account deficit, the broadest measure of trade in goods and services, has averaged about 5% of gross domestic product over the past four years and the budget shortfall about 4%.
The combination of these gaps, and slowing economic growth, is “unsustainable and inflationary, progressively weakening growth prospects,” the central bank said.
The nation is at risk of losing its investment-grade credit rating and investor confidence has been undermined by President Jacob Zuma’s surprise firing of his finance minister in December, followed by the Constitutional Court's ruling last week that he violated the constitution by refusing to repay government money.
Moody’s Investors Service visited South Africa last month after putting its credit rating on review for a possible downgrade. A reduction would put its assessment one level above junk and on par with that of Standard & Poor’s and Fitch ratings.
A downgrade to junk will probably lead to further depreciation of the rand against major currencies and will exacerbate price pressures, the Reserve Bank said.
A downgrade of South Africa’s credit rating “is possible”, deputy governor Daniel Mminele said at a forum discussion after the release of the report on Monday. “The risks of a credit-rating downgrade have increased.”