The most recent inflation print surprised on the low side as headline CPI advanced just 4.7% in the year to June 2015. However, the Bank is looking forward and seeks to get ahead of the curve as the US prepares for an increase in the Federal funds target rate.
The MPC noted inflation is expected to breach the 6% upper end of its target range for two consecutive quarters in 1Q16 and 2Q16. Also, given a still wide current account deficit, the Bank is clearly concerned about the possible impact of the expected shift towards US monetary policy normalisation on the rand and hence domestic inflation.
Even though the feed-through impact of rand weakness into inflation has been modest in recent years, wage growth is firm and inflation expectations for the next two-and-a-half years are sticky at around the upper end of the Bank's inflation target range. The concern is that sustained rand weakness could translate into further increases in inflation expectations and an upward wage-inflation spiral.
The MPC acknowledges that growth is weak with risks skewed to the downside. Indeed, recent high frequency data, including a decline in manufacturing production, suggests the economy grew by very little in the second quarter of 2015 (if at all), while the Reserve Bank's leading economic indicator for real economic activity suggests an improvement is not imminent.
Since the output gap (a measure of the level of capacity utilisation in the economy) plays a role in the Bank's inflation forecasting model, the MPC does, implicitly, consider economic growth when it makes monetary policy decisions. But, what yesterday's decision clearly illustrates is that the inflation outlook remains the Bank's primary concern.
By maintaining a low, stable inflation rate, the monetary policy authorities make an important contribution to economic growth in the long run. But in the end, there is little the Bank can do to lift South Africa's economic growth profile. For that we need to address South Africa's numerous, well-documented, supply-side constraints. Indeed, given these constraints, the Bank assumes a "current" potential real growth rate for South Africa of little more than 2%.
The MPC Statement is careful to observe that future monetary policy decisions are data dependent. Overall, though, given the expected upward trajectory in inflation into 2016, the real repo rate remains low and the FRA market continues to expect further repo rate hikes.
