S. Africa CPI Expectations Can Be Self-Fulfilling, SARB Says

(Bloomberg) -- South Africa's central bank is concerned that rising inflation expectations can become a self-fulfilling prophecy, according to Deputy Governor Daniel Mminele.

While the central bank's flexible inflation targeting allows monetary policy to see through first-round price effects, the greater danger is “second-round inflationary impacts,” Mminele said in a copy of a speech posted on the Reserve Bank's website on Wednesday. People “will demand compensation in line with their inflation expectations to protect their purchasing power, resulting in rises in input costs and eventually in the general price level.”

The Monetary Policy Committee raised its benchmark repurchase rate by 125 basis points since last July to 7 percent as it sought to steer price growth back into its 3 percent to 6 percent target band, even as the central bank forecast the economy will expand at the slowest pace since a 2009 recession this year. While inflation slowed to 6.1 percent in May it will only return to the target by the third quarter of 2017, according to the Reserve Bank. The MPC is due to announce its next interest-rate decision on July 21.

Inflation pressures are underpinned by the weak currency and food costs, Mminele said. The rand has lost 22 percent against the dollar since the start of last year and the worst drought in more than a century has pushed up food prices.

The rand weakened 0.6 percent to 14.8288 per dollar by 4:07 p.m. in Johannesburg on Wednesday. Yields on rand-denominated government bonds due December 2026 fell one basis point to 8.81 percent.

“The MPC is sensitive to the possible negative effects of policy tightening on cyclical growth,” Mminele said. The bank will “remain focused on the mandate of maintaining price stability in the interest of ensuring sustainable growth over the medium term.”

South Africa is likely to be affected indirectly by the U.K.'s vote to leave the European Union through heightened market volatility and the effects on the global economy, Mminele said. The Reserve Bank's most recent forecast that economic growth will recover to 1.7 percent by 2018, from a projected 0.6 percent this year, does not factor in the possible spill-over effects of Brexit, he said.

S&P Global Ratings kept South Africa's credit assessment at BBB-, one level above junk, on June 3 and warned it could cut the nation's debt evaluation unless more is done to foster growth and combat political and labor instability. Fitch Ratings Ltd. also kept its evaluation of South Africa's debt at one level above junk last month and Moody's Investors Service left the nation at two levels above non-investment grade in May. S&P is due to announce its next rating assessment in December.

The “sovereign credit rating has been a source of market uncertainty for some time,” Mminele said. In the absence of progress on the issues that the rating companies highlighted, “the risk of downgrades during the next reviews towards the end of this year should not be underestimated,” he said.

To contact the reporter on this story: Arabile Gumede in Johannesburg at agumede@bloomberg.net. To contact the editors responsible for this story: Rene Vollgraaff at rvollgraaff@bloomberg.net, John Viljoen