Excerpts from the statement by Governor Lesetja Kganyago:
The inflation forecast of the SARB has shown a moderate improvement despite the adverse impact of the VAT increase due to be implemented in April. This increase, combined with base effects and other indirect tax increases, implies that the low point of the inflation cycle was reached in the first quarter of 2018, at a forecast average of 4.1%. Headline inflation is expected to average 4.9% in 2018 (unchanged from the previous forecast), 5.2% in 2019 (down from 5.4%), and 5.1% in 2020. A peak of 5.5% is expected by the first quarter of 2019 before the VAT increase falls out of the data. The forecast for core inflation is unchanged at 4.6% for 2018 and is 0.2 percentage points lower, at 4.9%, for 2019. It is expected to remain unchanged at 4.9% in 2020.
The main changes in the forecast related to the VAT increase and the exchange rate. The VAT increase is expected to add about 0.6 percentage points to the headline inflation trajectory for the four quarters from the second quarter of 2018, with marginal second-round effects persisting into subsequent quarters. The improved exchange rate has softened the impact of the indirect tax adjustments on the inflation forecast. The implied starting point for the rand is R11.97 against the US dollar compared with R12.90 at the time of the previous MPC meeting.
Since the previous meeting of the MPC, the rand has appreciated by 4.8% against the US dollar, by 3.2% against the euro, and by 3.5% on a trade-weighted basis. At current levels, the SARB’s model assesses the rand to be somewhat overvalued, and further strengthening potential is probably limited.
The domestic economic growth outlook for this year is more favourable but remains challenging. This follows an upward revision of historical gross domestic product (GDP) data and a fourth-quarter outcome of 3.1% which surprised on the upside. Following an annual growth rate of 1.3% in 2017, the SARB expects a growth rate of 1.7% for 2018 compared with 1.4% previously. The forecast for 2019 is 1.5%, marginally lower than the previous forecast of 1.6%, while a growth rate of 2.0% is forecast for 2020. At these growth rates, the negative output gap, which measured -1.1% in 2017, is expected to close in 2020.
The MPC assesses the risks to the inflation forecast to be more or less evenly balanced. Some of the key domestic risks and uncertainties that overshadowed the outlook in recent meetings have abated. The government budget was generally well received, but implementation risks remain. While the recent sovereign ratings outcome was positive for the rand, further sustained appreciation of the local currency is not expected. The exchange rate is currently assessed to be less of a risk to the inflation outlook. However, the rand will remain sensitive to a faster pace of normalisation in the advanced economies, possible heightened global financial market volatility, as well as domestic developments.
The MPC was of the view that, in light of the improved inflation outlook and the moderation in risks to the forecast, there was some room to provide further accommodation without undermining the inflation trajectory or the downward trend in inflation expectations. Accordingly, the MPC has decided to reduce the repurchase rate by 25 basis points to 6.5% with effect from 29 March 2018. Four members preferred a reduction while three members preferred an unchanged stance.