Deciding when to adjust interest rates to mitigate inflationary pressures was a headache for the SA Reserve Bank's monetary policy committee (MPC), governor Tito Mboweni said on Tuesday.

"The timing of the action the central bank must take is very important," he said in Pretoria at the presentation of the bank's latest monetary policy review.

"To get that balance is very difficult."

There was already evidence of initial pressure, largely because of high international oil prices, passing through to inflation, Mboweni said.

He would not be pressed on when the central bank was likely to move, but said: "If the situation deteriorates, the bank will have to act".

Some argued that taking action only after signs of second round effects became apparent, would be too late. "We can debate this until the cows come home".

In its review, the bank said the CPIX measure of inflation was expected to remain within the target range of three to six percent until the end of 2007, despite pressure from high oil prices.

"Expectations are still in line with the inflation target and there does not appear to be a widely-held belief that inflation is likely to get out of control." However, a continued deterioration in inflation expectations would be of concern given its role in price and wage determinations.

It was essential to take action to ensure the inflation target continued to be met.

The central bank determines the repo rate at which it lends money to commercial banks on the basis of movements in CPIX — consumer inflation minus mortgage costs.

The bank's own forecast was for CPIX to rise to about 5.8 percent in the second quarter of next year, easing to 5.3 percent in the final quarter of 2007.

"The probability that the CPIX inflation rate will remain within the inflation target range in the final quarter of 2007 is approximately 70 percent."

But, Mboweni said this forecast was not the major factor in determining monetary policy.

Many things could change between now and 2007, he said. These included oil prices, unit labour cost and the exchange rate of the rand.

"By the time of the MPC's next meeting, the picture may be better or worse," Mboweni said

While the MPC would not react to first-round effects of higher oil prices, it had to anticipate second-round effects, according to the review document.

"Although at the time of the October meeting there was no conclusive evidence of these effects, the MPC warned that the increased risk of this happening would inform future policy making."

The first-round effects of fuel price increases became apparent in October. The effects of robust domestic demand, reflected in accelerated credit extension, were also being closely watched.

There was little monetary policy could do to avoid the initial effects of inflation, the review document added.

"The view of the committee is that the appropriate action would be to accept such first-round increases and to focus on preventing these price increases from being passed on - the so-called second-round effects."

Interest rate changes took between 18 and 24 months to fully work through to prices. Monetary policy had to weigh the risk of taking "potentially unnecessary or incorrect action by being too pre-emptive", against the cost of waiting too long.

"The problem for policy makers is that the future is inherently uncertain."

Inflation has remained within the target range for 25 consecutive months.

At 3.9 percent in May and 3.5 percent in June, CPIX inflation then rose to 4.8 percent in August and receded slightly to 4.7 percent in September.

Quarterly CPIX inflation accelerated from 2.4 percent in the first quarter of this year to 4.6 percent in the second, and 6.3 percent in the third.

If one excluded energy prices, the year-on-year rate of increase in CPIX was 3.3 percent from March to June, 3.6 percent in July and August, and 3.5 percent in September, the review found.

Crude oil prices more than doubled from the beginning of last year to record-highs approaching $70 per barrel by this August, before declining to below $60 per barrel in October.

Year-on-year growth in remuneration per worker slowed in the second quarter of 2005, but labour productivity growth weakened more. This resulted in growth in unit labour cost from 3.8 percent in the first quarter of this year to 4.5 percent in the second.

Growth in real final consumption expenditure by households increased from 5.5 percent to 5.9 percent from the first to second quarters, while household debt as a percentage of disposable income rose from 60 percent in the first quarter to 62 percent in the second.

Sapa

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