http://www.engineeringnews.co.za/article/monetary-policy-focus-remains-on-hitting-inflation-target-marcus-2011-11-15

Monetary policy focus remains on hitting inflation target – Marcus

Published 15 Nov 11        By: Brindaveni Naidoo
The Reserve Bank would maintain its monetary policy focus on achieving the inflation target of between 3% and 6% over the medium term, but would remain sensitive to the domestic economic situation, governor Gill Marcus said on Tuesday.

The “challenging times of uncertainty and possible unthinkable consequences in the European environment”, made it difficult for South Africa to pre-empt its policies, she said at a Swiss Chamber of Southern Africa event in Johannesburg.

The Reserve Bank kept its repo rate at a 30-year low of 5.5% last week.

Marcus said that there was a risk of stagflation in the domestic economy, with inflation rising and domestic growth still sluggish.

It still appeared that inflation was being driven by cost-push factors, as illustrated by the benign core inflation outcomes. However, the interaction between higher headline inflation and inflation expectations of wage and price setters was critical, Marcus said.

“To date inflation expectations appeared to be anchored at around the upper level of the target range, but the longer inflation remained outside the target, particularly if it surprises on the upside, the more precarious these expectations become, and the greater the upside risk to the inflation outlook,” she explained.

The Reserve Bank, she said, saw medium-term inflation outside the target range at this point, and regarded the breach, although extended, to be temporary.

In addition, the weak state of the economy also impacts on the approach taken.

“But we have to be vigilant on both sides. There is always a possibility of upside surprises to growth or a dislocation of inflation expectations from the target range, which could take inflation well above the target range.

“However, on the other side, although our assumption for European growth has been lowered, it does not contain the worst case scenario of a meltdown in the eurozone, which would have severe implications for the global economy and South Africa. Although this is seen as a tail risk, it is not a remote possibility.”

Also, the volatility of the rand would be determined by bouts of risk aversion in global financial markets.

The general expectation, said the governor, was that the rand was unlikely to return to previous levels of below R7 to the dollar, but to appreciate somewhat from current levels.

But, she said that a weaker rand also comes with its advantages, making exports more competitive and imported goods more expensive - providing a boost to domestic producers.

“This is in effect an easing of monetary conditions for domestic producers. However, this advantage will be short-lived if offset by higher wage and other input costs which offset the advantage faced by producers.”

But Marcus pointed out that an accommodative environment could not, on its own, generate the higher rates of growth that the South African economy required for employment creation.

Part of the solution, she explained, would need to come from improving much-needed infrastructure, such as in the energy, rail and ports sectors, which would strengthen export capacity.

There was also a need for sustained efforts to enhance South Africa’s ties with its traditional trading partners and also develop new trading relationships outside the eurozone.

“In these troubled times, it is important that trade relationships are not only preserved but enhanced. We are certainly living in interesting but difficult times, because the possibility that things can go horribly wrong is very high,” she said.