S.Africa central bank raises rates,warns on inflation

By Lucia Mutikani

PRETORIA- South Africa’s central bank raised interest rates on Thursday, warning the inflation outlook had deteriorated markedly and predicting the benchmark CPIX gauge would breach the upper end of its target range next year.

The deci

sion to increase the repo rate by 50 basis points to 7.50 percent had not been widely anticipated, and prompted sharp falls in government bonds and domestic shares. Only 3 of the 19 economists polled by Reuters last week had forecast a rate hike.

South Africa’s Reserve Bank last raised its repo rate in September 2002. Commercial banks promptly increased prime lending rates by the same margin to 11 percent.

“Compared to the previous forecast of the bank, the latest forecast shows a marked deterioration in the inflation outlook, particularly in the short term,” Reserve Bank governor Tito Mboweni said in a televised address.

“The main reason … is a significant upward revision of the international oil price assumptions.”

The bank now expects CPIX inflation to breach the upper end of its 3-6 percent target band, peaking at 6.2 percent in the first quarter of 2007. The index, which excludes home loans, had been previously forecast peaking just below 5 percent.

“CPIX inflation is then expected to fall back below the upper end of the target by the next quarter, and by the third quarter it is projected to decline further to 5.2 per cent,” Mboweni said.

“Inflation is then expected to continue to moderate gradually to reach 4.8 per cent by the end of 2008.”

Annual inflation measured by CPIX has remained inside its target band for 32 consecutive months, rising by an annual rate of 3.7 percent in April from 3.8 percent in March.

PRICE PRESSURES OVER-ESTIMATED?

Factors seen stoking price pressures include high global oil prices, robust domestic demand — which is weighing on the current account — and the rand’s recent sharp depreciation.

Mboweni pointed out that the currency has declined by 13 percent versus a trade-weighted basket of currencies since the last monetary policy meeting in April.

Many economists said the central bank may have overestimated inflationary pressures, and cautioned that economic growth may be sacrificed.

“My feeling is the Reserve Bank has responded incorrectly … the risk is that inflation will remain at the bottom end of its target range rather than at the middle. Prospects for GDP growth are put at risk,” said Colen Garrow, economist at Brait.

The central bank gradually reduced the repo rate by 6.50 percentage points between 2003 and 2005, driving prime lending rates to 10.5 percent — their lowest in more than 2 decades.

Interest rates have been on hold since April 2005. The low interest rate environment has fanned strong domestic consumption, which is driving faster economic growth.

“The big surprise is the huge extent to which the inflation outlook has jumped. I think it needs to be seen in the context that inflation is being over-forecast,” said Chris Hart, an economist at Absa Treasury.

“I suspect that we night have to end up undoing this hike later this year.”

The central bank sought to allay fears that this could be the start of a tightening campaign, and described the half a percentage point hike as moderate.

“I do not think the statement contains indications that this is the beginning of many increases or a measured pace (of rate increases). It was a comfortable consensus decision. I cannot pretend that there were many dissenters,” Reserve Bank executive manager Bertus van Zyl said in an interview on SABC television. — Reuter