The SA economy powers along -Economic Prospects, 2nd Quarter 2007

Both global and domestic financial markets have shrugged off the jitters that surfaced in May/June last year and late February this year and the SA economy remained remarkably resilient in the face of higher interest rates.

It is difficult to assess whether this strength relates to late cycle buoyancy or
whether it is related to underlying bullish forces.

While the favourable external factors are adding fuel to economic growth, they are not the fundamental drivers. A structurally lower domestic inflation environment, reflected in well-anchored inflation expectations, sound fiscal stimulation, accelerated employment creation and a higher fixed investment rate are all elements of the domestic economic performance. The more competitive level of the currency is also stimulating the manufacturing sector, which is capturing a larger share of the growth in the buoyant domestic market (i.e. replacing imports) and with exports in certain industries doing better.

The BER has upgraded its short-term outlook for the SA economy, mainly due to the resilience in the consumer sector, a fierce fixed investment momentum and stronger than expected export growth. A number of risks remain - global economic imbalances, the oil market, domestic balance of payments concerns, etc. - which could still lead to more trying growth conditions. Suffice it to say that the imminence of these risks has softened in the BER's view. Real GDP growth is now forecast to come in at 4.8% in 2007 (4.5% previously) and 5% next year (4.5% previously).

The global economy should survive a US slowdown
Global economic prospects remain upbeat in the sense that the interest rate induced slowdown in key parts of the world is expected to be of a contained nature. The US economy is currently experiencing a soft landing and is expected to avoid a full-blown recession. Outside of the USA current economic conditions
remain lively, with the Euro area and Japan in particular putting in strong performances during the fourth quarter of 2006. The Chinese economy continues to grow at double digit rates and growth remains strong in other emerging economies. Commodity prices improved during the early months of 2007 and are
expected to remain well-supported over the short term.

Domestic inflation expectations remain well-anchored
The bottom line regarding the short-term inflation picture is the probability that CPIX inflation will continue to trend close to the upper 6% inflation target level. This implies significant risk of interest rate increases in case prospects of a breach become clearer. Fortunately, inflation expectations are wellanchored.
Inflation expectations in respect of both 2007 and 2008 - poised at just above 5% - declined during the first quarter of 2007. The lower inflation expectations and the persisting gap between PPI and CPI inflation point to smaller inflation pass-through from the supply-side shocks to inflation in 2006.  Excluding food and energy prices, CPIX inflation amounted to 3.9% and 4% in January and February 2007 respectively.

The SARB decided to pause with interest rate hikes in February, despite the demand pressures in the economy and the exchange rate risks tied to the widening current account deficit. While a strong case can be made for a continued tightening of monetary policy at the present point in time, there may be a good
chance that CPI inflation will remain under control given the structural changes in the domestic inflation environment and as long as the growth continues, foreign investors will remain positively inclined to invest locally. The Bank may be opting for "giving economic growth a chance", i.e. see what maximum real economic growth rate we may achieve with the least costly monetary policy (for instance by targeting the upper 6% level of the CPIX inflation target). At the present point in time this implies leaving interest rates unchanged and monitoring the inflation, balance of payments and economic growth configurations closely. This approach is experimental and one could certainly add - risky.

Upgrading the real GDP growth forecast
The resilience of the consumer sector, a fierce fixed investment momentum and higher than expected export growth have led the BER to project a continuation (over the short term) of the recently acquired 5% real GDP growth tempo of the SA economy. The outlook for all three these demand components of GDP have been revised upwards. Sustained business and consumer optimism are good
leading indicators of continued robust economic growth. During the first quarter of 2007, the RMB/BER business confidence index remained above the level of 80 index points for the 8th consecutive quarter, while the FNB/BER consumer confidence index reached a new record high of 23 index points.

Household consumer spending has remained remarkably resilient in recent months following the hike in interest rates since June 2006, the depreciation of the rand and the increase in inflation. To understand the resilience of consumer spending it is important to appreciate the income component of spending. With robust fixed investment spending across many sectors, employment growth is taking place
and this is boosting household financial positions. The notion of 'jobless growth' simply no longer applies as was the tendency during the second half of the 1990s.

Another encouraging trend is the fact that the manufacturing sector is capturing a larger share of the buoyant growth in the domestic market (by replacing imports). The March 2007 Quarterly Bulletin of the SA Reserve Bank also reports healthy export growth towards the end of 2006, part of which are accelerated manufacturing exports. The high level of consumer confidence during the first quarter of the year suggests that the anticipated slowdown in consumer spending will probably arrive later and will be of more moderate proportions than previously forecast. The second half of the year is likely to witness a more significant slowdown in durable and semi-durable goods consumer spending, as well as private residential construction. Sustained income growth on the back of fixed investment spending and employment creation is expected to remain an important countervailing force to ensure around 5% overall real GDP growth. As
noted, the major risks remain on the downside given the otherwise benign outlook.