US embassy cable - 05PRETORIA4215

UNCLAS SECTION 01 OF 02 PRETORIA 004215 
 
SIPDIS 
 
DEPT FOR AF/S/MTABLER-STONE; AF/EPS; EB/IFD/OMA 
USDOC FOR 4510/ITA/MAC/AME/OA/JDIEMOND 
TREASURY FOR OAISA/JRALYEA/BCUSHMAN 
USTR FOR PCOLEMAN 
 
 
E.O. 12958: N/A 
TAGS: ECON, EINV, EFIN, ETRD, BEXP, KTDB, PGOV, SF 
SUBJECT: South Africa: SARB Leaves Interest Rates Alone 
 
 
1. (U) Summary.  Citing high oil prices, rising inflationary 
expectations, and higher global inflation as increasing the 
risk of inflation in South Africa, the South African Reserve 
Bank (SARB) decided to leave interest rates unchanged at its 
October 12-13 meeting of the Monetary Policy Committee 
(MPC).  Although the impact of substantially higher fuel 
costs has not yet translated into higher prices for other 
goods and services, the SARB felt that the prospect of even 
higher oil prices did pose significant inflationary risk. 
The SARB also cited the Bureau of Economic Research's latest 
survey indicating that inflationary expectations had risen. 
The SARB expects inflation to remain below the 6% ceiling, 
but now believes that inflation will peak at a level just 
below 6% sometime during the first two quarters of 2006. 
Real interest rate differentials with the United States 
remain relatively high.  End Summary. 
 
Staying the Course 
------------------ 
 
2. (U)  Citing high oil prices, rising inflationary 
expectations, and higher global inflation as increasing the 
risk of inflation in South Africa, the South African Reserve 
Bank (SARB) decided to leave interest rates unchanged at its 
October 12-13 meeting of the Monetary Policy Committee 
(MPC).  Although the impact of substantially higher fuel 
costs has not yet translated into higher prices for other 
goods and services, the SARB felt that the prospect of even 
higher international oil prices continued to pose a 
significant inflationary risk to the South African economy. 
In August, consumer prices minus mortgage costs (CPIX) 
increased by 4.8%.  If fuel costs were excluded, CPIX would 
have increased by 3.6% -- the same as in July.  For the 
previous 12 months, CPIX excluding fuel costs has averaged 
3.4%, indicating that there has been limited pass-through of 
higher fuel costs to the domestic prices of other South 
African goods and services.  The decision means that the 
repurchase rate remains at 7%.  Prime lending rates have 
stayed at 10.5%. 
 
Inflationary Expectations 
------------------------- 
 
3. (U) Of particular note was that the SARB has adjusted its 
inflation forecast upwards since the MPC's last public 
pronouncement in August.  While the SARB still expects 
inflation to stay within its 3-6% target range, it now 
predicts that inflation will peak just below 6% sometime 
during the first two quarters of 2006.  In the MPC's August 
report, the SARB forecasted that inflation would peak at 
5.3%.  The adjustment is supported by an upward trend in 
producer prices.  In May 2005, producer prices increased 
2.4% but in August they rose 4.2%.  Trends in consumer 
prices generally follow those in producer prices. 
 
4.  The adjustment is also supported by the latest inflation 
expectations survey conducted by the Bureau for Economic 
Research (BER) at the University of Stellenbosch.  The BER 
survey now predicts CPIX inflation to rise 5.2% in 2006 and 
5.4% in 2007, as compared to 4.9% and 5%, respectively, in 
its last survey. 
 
Domestic Demand Still Strong 
---------------------------- 
 
5. (U) Domestic demand, which has been the primary driver of 
growth in the South African economy during the past year, 
remains robust, albeit showing signs of moderation.  Retail 
sales grew by 3.2% in July.  New vehicle sales increased by 
26.5% in September.  Much of the increase in consumer demand 
has been financed by increased borrowing stimulated by 
historically low interest rates.  Both money supply and 
credit demand grew by 19% and 18.3% in August.  Rising 
disposable income and relatively low interest rates have 
supported increased household borrowing.  Household debt as 
a percentage of disposable income rose from 60% in the first 
quarter 2005 to 62% in the second.  However, relatively 
lower interest rates have meant that debt service as a 
percentage of disposable income has remained unchanged at 
6.5%. 
 
6. (U) Strong retail sales and falling inventories have 
helped manufacturing production rebound 3.5% in the second 
quarter 2005, after a decline in the first quarter.  This 
also translated into more manufacturing jobs.  Formal non- 
agricultural employment increased 7.6% (q/q), representing a 
gain of 84,000 jobs in the second quarter 2005. 
 
Real Interest Rate Differential Still High 
------------------------------------------ 
 
7. (U) South African real short term interest rates are 
still relatively high when compared to those in the U.S. 
The real repurchase rate is 3.1% while the real federal 
funds rate is only 0.15% (i.e., federal funds rate at 3.75 
and U.S. CPI inflation at 3.6%).  The size of this 
differential keeps the rand an attractive investment and 
supports its value against the dollar.  In turn, the strong 
rand has helped to mitigate the rising cost of imported oil. 
This may be coming to an end.  In recent months, the rand 
has weakened slightly, and it weakened a bit more after the 
MPC announcement to R6.62 to the dollar (at 3 p.m. EST on 
October 13), as compared to 6.54 on October 12. 
 
Comment 
------- 
 
8. (U) The MPC decision to leave the repurchase rate alone 
was no surprise to economists and market analysts.  That the 
foreign exchange market reacted with a slight drop in the 
value of the rand would seem to support the MPC's decision 
not to lower interest rates in the face of inflationary 
expectations.  Economists expect the SARB to increase 
interest rates once higher oil prices propel inflation via 
energy-intensive industries.  Rising inflation could get in 
the way of the SAG economic agenda to ratchet growth to 6% 
by 2014.  How the SARB manages interest rates to control 
inflation will be crucial to the SAG's pursuit of its growth 
agenda.  TEITELBAUM