November 5, 2003

By Quentin Wray

Johannesburg - Interest rates are likely to remain at current levels or move even lower in the next 18 months, following the release of the Reserve Bank's inflation forecasts. These show that CPIX inflation, which strips out interest on mortgages, is expected to remain within its target range of 3 percent to 6 percent until at least the end of next year.

Because the lag between changing interest rates and the effect of these changes on inflation runs to about 18 months, the bank uses its inflation forecasts as an "important part of the monetary policy decision-making process".

It said:

"In principle ... interest rates should be set on the basis of the divergence of the central forecast from the inflation target. Thus if the [18-month to two-year] forecast is above the inflation target, interest rates should be raised and if it is below, interest rates should be reduced."

The bank stressed that although its monetary policy committee was guided by the forecasts, it did not follow them in a "mechanical way".

The bank's monetary policy review, released yesterday, showed that the bank expected CPIX to move into the target range in the last quarter of this year and remain "at around the midpoint" of the range next year.

"The probability distribution for this forecast implies that there is approximately a 55 percent probability that the CPIX inflation rate will be between 3 percent and 6 percent in the final quarter of 2004," the bank said.

It would edge higher in 2005 but was expected to remain within the target range throughout the current forecast period, which ends then.

The central bank's view tallies with a September Reuters poll of private sector economists, which predicted CPIX would average 4.9 percent next year and 5.4 percent in 2005.  

Falling inflation has seen the bank's monetary policy committee cut interest rates four times this year, bringing the prime lending rate down from 17 percent to 12 percent - a level last seen in the mid-1980s.

The Reuters poll predicted that the prime rate would average 12 percent next year and 12.5 percent in 2005.

The 3 percent to 6 percent inflation target for the period 2002 to 2005 was set by the national treasury in consultation with the central bank. Finance minister Trevor Manuel is expected to announce the target for 2006 next Wednesday, when he presents his medium-term budget policy statement to parliament.

The bank said that whether the lower interest rates could be maintained depended on the sustainability of the positive factors that underpinned the inflation outlook.

These included international inflationary pressures remaining very low, with the International Monetary Fund's inflation forecasts for advanced countries remaining below 2 percent this year and falling to a 30-year low of 1.3 percent next year. Developing country inflation was expected to fall to just over 5 percent.

Oil prices were already near the top of oil cartel Opec's price range, meaning that no significant oil price increases were expected.

Locally, robust growth in real government spending and fixed capital formation had raised the potential growth rate of the economy, and faster growth could be accommodated without inflationary pressures being generated as quickly as in the past.