Moneyweb

by Ruth Stroppiana and Mekael Teshome

Reserve Bank kept its policy interest rate at 6.5%

The South African Reserve Bank held the repo rate, its monetary policy interest rate, at 6.5% at its July meeting. Wage increases well above the rate of inflation are raising caution flags for medium-term inflation. The SARB cut the benchmark rate by 50 basis points in March, but with rate cuts totaling 5.5 percentage points since December 2008, the central bank is concerned that an extra monetary stimulus would have to be counteracted by additional tightening as the recovery strengthens.

The latest threat to the global recovery posed by the fiscal crisis in southern Europe has also prompted policymakers to tread carefully in the interest of stability. Volatility in European markets could heighten risk aversion and send capital flowing out of emerging markets. This would likely weaken the rand, adding to inflation pressures by raising prices for imported goods.

South African exporters and labour unions have stepped up pressure on monetary authorities in recent months to cut rates and weaken the currency. Factory data have disappointed, suggesting manufacturing's rebound is losing momentum. The faltering recovery in Europe, a key export market, could also hinder South Africa's manufacturing-driven recovery. At 25.2% in the first quarter, the unemployment rate in South Africa remains the highest among G-20 nations.

Still, the SARB may not need to pump in an additional stimulus to reinforce the recovery. Recent retail sales data indicate consumer demand is strengthening. This augurs well for growth, as private consumption accounts for more than 60% of South Africa's gross domestic product. Although inflation trends have been moving in the SARB's favour, with the headline annual CPI rate remaining comfortably within the 3% to 6% target range in recent months, we expect the bank to err on the side of stability and leave monetary policy on hold for the remainder of 2010.

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