SOUTH AFRICAN RESERVE BANK TALKS TOUGH ON INFLATION

UNCLAS PRETORIA 001053 SENSITIVE SIPDIS E.O. 12958: N/A TAGS: ECON EFIN SF SUBJECT: SOUTH AFRICAN RESERVE BANK TALKS TOUGH ON INFLATION ¶1. (SBU) Summary: Inflation continues to rise in South Africa. Food and fuel prices are the major culprits, but there are signs that inflationary pressures are becoming generalized. South African Reserve Bank Governor Tito Mboweni advocates tighter monetary policy, even though the economy is already slowing down after nearly two years of interest rate hikes. South Africa may have entered a period of high inflation and high interest rates, with GDP growth falling below 4.0 percent per year. End Summary. -------------- Doing What It Takes to Whip Inflation -------------- ¶2. (SBU) South African Reserve Bank (SARB) Governor Tito Mboweni believes that higher interest rates are needed to curb inflation in South Africa, even though GDP growth is already slowing down in response to a series of nine 50-basis-point interest rate hikes since June 2006. Mboweni delivered his tough words on inflation at the SARB's Monetary Policy Forum in Pretoria on May 13. Warning the crowd of economists and financial analysts that inflation is continuing to mount in South Africa and many other countries, he said, "These are tough times for central banks all over the world. We (SARB) will get tough, too." He left no doubt about where he stood on interest rate policy, saying, "Monetary policy will get tighter if I have my way." Note: The Monetary Policy Forum is a semi-annual public event where SARB officials review the inflation outlook and explain monetary policy. End Note. ¶3. (SBU) Mboweni spoke after SARB officials had reported that CPIX inflation (CPI less mortgage interest) was 10.1 percent (y/y) in March. This was notably higher than the rate of 9.4 percent (y/y) in February, and well above SARB's inflation target of 3.0-6.0 percent for the twelfth consecutive month. The officials singled out food and energy prices as the main culprits behind the higher prices, but they warned that signs of generalized inflation are now emerging in the economy. They noted that even when food and energy prices are excluded from CPIX, inflation increased from 4.9 percent (y/y) in September 2007 to 5.6 percent (y/y) in March 2008. ¶4. (SBU) Taking questions after the technical presentation, Mboweni re-emphasized the point that inflationary pressures are no longer limited to food and fuel, saying, "Inflation is now generalized." He pledged that SARB will take firm steps to "anchor" inflation expectations in coming months. "I promise you: We will do this come hell or high water." -------------- Inflation-Targeting, Whatever the Name -------------- ¶5. (SBU) Mboweni also fended off criticism that South Africa's inflation-targeting policy has tied SARB's hands and forced it to use interest rates to battle inflation caused by supply shocks, not demand pressures. "All credible central banks keep inflation at low levels," he explained. "We have no choice but to keep inflation in line with inflation in our major trading partners, especially Europe. It doesn't matter whether we call it inflation-targeting or something else." Inflation-targeting remains government policy, he said. Note: Labor unions and some business groups have been sharply critical of South Africa's inflation-targeting policy, which they believe has dampened growth. The new ANC leadership has called for a national debate on the issue. End Note. -------------- Higher Prices, Slower Growth -------------- Q -------------- ¶6. (SBU) In meetings with Deputy Economic Counselor, economists at Absa Capital and Barnard Jacobs Mellet had no doubt that the policy interest rate will be raised at the next meeting of SARB's Monetary Policy Committee in June. "Given what Mboweni said, rates might go up 100 basis points," one said. Both were skeptical that CPIX inflation would fall back within the target band by the end of 2009, as SARB currently forecasts. They warned that South Africa has apparently entered a period of high inflation and high interest rates that could last through 2010, or even 2011. In this environment, annual GDP growth would probably not exceed 4.0 percent, especially given the uncertainties about power supply. The economists agreed, though, that loose talk of a recession is "ridiculous," as high commodity prices and strong public sector investment would prop up growth. Note: Growth averaged 5.0 percent per year from 2004 to 2007. End Note. -------------- Comment -------------- ¶7. (SBU) Mboweni's warning that SARB will do whatever it takes to anchor inflation expectations is aimed, in part, at upcoming wage negotiations in key sectors, where unions are pressing for double-digit wage increases to offset higher consumer prices. There is concern in SARB that unrealistic wage settlements could fuel generalized inflation pressures. BOST