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Economic Prospects, 3rd Quarter 2007: A more challenging macroeconomic environment with 5.0% growth

14 August 2007 Bureau for Economic Research

The South African economy has recently had to face a number of challenges. The country has not only been hit by a spate of industrial action, but worse than expected inflation and interest rate developments have necessitated a more negative view on these variables going forward.

Despite these negative developments, the Bureau for Economic Research (BER) is (compared to our previous forecast run in April) more optimistic about the countrys growth outlook. "To a large degree the optimism is based on the relative ease with which the consumer has so far been able to cope with a more challenging macroeconomic environment", said BER economist Hugo Pienaar. Amongst other things, expectations that employment growth will remain robust should help to shield the disposable income of households against the negative impact of higher food costs and interest rates.

Mainly as a result of upwardly revised capital expenditure plans from public corporations such as Eskom and Transnet, as well as better than expected private residential investment during the first quarter of 2007, the outlook for fixed investment is also more favourable. The implication of these adjustments to the short-term economic outlook is that real gross domestic expenditure (the broadest measure of spending in the economy) is likely to be quite a bit stronger this year (6.2% compared to 5.2% projected previously), while the view on export growth has remained largely unchanged. The ultimate result is that the BER now sees GDP growth remaining at 5.0% during 2007, thus unchanged from last year. This is an upward revision to the April and January forecasts which saw 2007 growth at 4.8% and 4.5% respectively. With the consumer likely to feel a bigger pinch from higher interest rates next year, GDP growth is forecasted to slow marginally to 4.8% in 2008.

Although world stock markets have recently been rocked by contagion from the US housing market woes, the outlook for global growth remains upbeat. In a July update to its April 2007 World Economic Outlook, the International Monetary Fund upped its 2007 and 2008 world growth forecast to 5.2% for both years from 4.9% previously forecasted. A robust global expansion is likely to support SAs growth performance.

Inflation, interest rates and the exchange rate

The SA Reserve Banks targeted inflation measure (CPIX) rose above the 6.0% upper target band on an annual basis in April and remained above the key level during May and June. The result is that the outlook for SA inflation (and thus interest rates) has worsened markedly since our April forecast. While external (food and energy) factors were the main drivers of the adverse inflation developments, there are signs that general price pressures are also accelerating. After averaging 3.2% in 2006, CPIX excluding food and energy accelerated to 4.9% year-on-year in May and June 2007.

On a more positive note, the rand has recently (mainly in reaction to US dollar weakness) traded stronger than expected. The BER expects only a gradual depreciation of the currency going forward, which should be positive from an inflation point of view. The rand is expected to average R7.40/$ and R10.14/ during the final quarter of the year. Lower commodity prices in 2008 could cause the currency to weaken to above R8/$ in the fourth quarter of next year.

The BERs updated inflation forecast reflects the recent worse than expected price data as well as the significant risks stemming from high international oil and food prices, sustained robust domestic demand, above inflation wage demands/settlements and higher electricity costs. CPIX inflation is expected to remain above 6% for the rest of 2007 as well as the first quarter of 2008. The average for 2007 is projected to be 6.2% (5.6% previously forecasted). CPIX is set to slow in the second half of 2008 to average 5.6% (against 5.2% at our previous forecast run) for the year as a whole.

In light of the higher inflation forecast, the BER expects another 50bps interest rate hike at the conclusion of this weeks MPC meeting. The baseline forecast is for no further rate rises thereafter, although (as with inflation) the risks are firmly tilted on the upside. It is certainly possible that a further 50bps hike could follow in October, especially if oil prices remain at current highs and real signs of slower consumer spending are not forthcoming. However, given the uncertainty related to (amongst other things) the influence of the National Credit Act (NCA) on consumer spending, we are cautious not to take an overly aggressive view on interest rates. The inflation outlook beyond the first half of 2008 looks more promising at this stage, which may result in a moderate interest rate decline during the latter stages of next year.

Financial market/data developments and the BERs forecast

The most recent forecast was completed at the end of June. Subsequently, global financial markets have shown fairly sharp moves the oil price surged close to $80/bbl, while the rand strengthened to R6.80/$ before weakening back above the R7/$ level lately. These sharp moves were not   anticipated, but because the stronger currency to a degree compensated for the dearer fuel costs, the recent developments have not impacted the BERs inflation forecast. With regards to consumer demand, the real impact of not only the NCA, but also the 250bps worth of interest rate increases since June last year is likely to be seen only in coming months. For this reason (along with an unchanged inflation forecast) the BER is sticking to its interest rate view as outlined above.

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