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South Africa: Bank Hints Rand Value May Be Key to Rates
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Business Day (Johannesburg)
20 March 2008
Posted to the web 20 March 2008
Mariam Isa
Johannesburg
THE rand's sharp slide will push inflation higher and outside its target range for longer than was anticipated earlier this year, raising the risk interest rates might have to rise again, Reserve Bank Governor Tito Mboweni said yesterday.
Mboweni said the extent of the currency's depreciation so far this year -- amounting to 20% on a trade-weighted basis -- would help to narrow the huge deficit on SA's current account, its broadest measure of trade in goods and services.
But he warned that the Bank would not hesitate to respond to any "second-round" effects of rising inflation, seen as inevitable after the deterioration in SA's inflation outlook since its last policy meeting in January.
"The (inflation) peak is going to be more elevated than we thought at the last meeting. It has to be, given the speed at which oil prices have gone up and the magnitude of the depreciation in the exchange rate," he said.
"In the short run, such depreciation of course raises the prices of imported items and may prolong the period during which inflation exceeds the target range," he said in a nother statement, released with the Bank's March quarterly bulletin.
Oil prices have climbed about 10% since the start of the year, while food prices -- the other main inflation driver -- have continued to notch up double-digit increases.
Both are global trends that higher interest rates cannot address, but the Bank has repeatedly said it will quash the "second-round" effect of rising prices, mainly a reference to inflation expectations, which rapidly feed into wages and price setting.
"We hope the second-round impacts will not continue to rise, forcing monetary authorities to tighten policy."
Mboweni said the rand's weakness stemmed mainly from the current account deficit, which widened to a 36-year peak at 7,3% of gross domestic product last year from 6,5% in 2006, though it narrowed in the final quarter as exports rose.
"I don't expect the exchange rate to depreciate further, for as long as we have foreign direct investment and other inflows. There are many other factors that support the exchange rate," Mboweni said, citing strong prices for commodities such as gold and platinum, which are key exports for SA.
Local markets did not react to his comments but forward rate agreements in the money market are pricing in a better than ever chance of a rate hike at the Bank's next policy meeting early next month.
"The market is a bit too sanguine about the interest rate outlook. The Bank will not be able to ignore the deterioration in inflation expectations," Citigroup's sub-Saharan Africa strategist Leon Myburgh said.
The Bank raised its key repo rate by four percentage points to 11% between June 2006 and December, but left policy on hold in January, putting more weight on the added threat to economic growth from a local power crisis.
There was scope to do this then as long-term inflation expectations were relatively unchanged since its previous meeting in December, staying below the upper end of the official 3%-6% inflation target.
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But inflation measured by the annual rise in CPIX has breached its target for 10 months running, rising by a near five-year record of 8,8% in January. It is now expected to peak above 9% this year, and remain outside the target until the second half of next year.
That compares with the Bank's January forecast of a peak at 8,5% in the first quarter, subsiding below 6% by the end of the year.
"While the lags involved in monetary policy make the instant resolution of situations where inflation moves outside of the target range impossible, the resolve of the Bank to bring inflation back within the target over time should not be underestimated," Mboweni said.
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