South Africa holds rates, weaker rand could fuel inflation

By Stella Mapenzauswa PRETORIA (Reuters) - South Africa's central bank left its repo rate unchanged as expected on Thursday, citing the inflation risk from a weaker rand when the U.S. Federal Reserve starts cutting back stimulus, reducing dollar flows into emerging markets. Governor Gill Marcus said the deterioration in the domestic growth outlook posed a policy dilemma, but with inflation "uncomfortably close" to the upper end of a 3-6 percent target range, there was no room for further monetary easing. Illustrating the fine balancing act global policy makers are all having to perform, Marcus told a news conference: "You learn to walk a tight-rope - and you hope there's a safety net underneath." The South African Reserve Bank last cut the repo rate, at which it lends to commercial banks, by 50 basis points to 5 percent in July 2012, in a bid to spur growth in an economy still struggling to shake off the impact of a 2009 recession. But price pressures fanned by the rand's depreciation -- the currency has fallen nearly 20 percent against the dollar this year alone -- have tied policy makers' hands on further loosening. "The Monetary Policy Committee continues to assess the risks to the inflation outlook to be on the upside, mainly as a result of further potential exchange rate pressures," Marcus said. "Tapering by the Fed is inevitable, but until a decision is taken financial markets globally are likely to experience heightened volatility," she added after the final policy meeting of the year. The rand was back under pressure early on Thursday after the latest minutes from the U.S. Federal Reserve suggested a scaling-back of its monthly bond purchases, which would deprive emerging markets of billions of dollars, is imminent. The currency edged up slightly against the dollar after the rates decision, while government bond yields extended earlier gains. The Reserve Bank slightly lowered its average inflation rates for 2013 and 2014 to 5.8 percent and 5.7 percent respectively, but warned that rand depreciation posed an increasingly upside risk to the outlook. All of the 21 economists surveyed by Reuters last week expected the central bank to keep the benchmark repo rate at the current four-decade lows of 5 percent. A slight majority expected the next move, an increase, to come in the second half of 2014 at the earliest. Marcus said the seven-member MPC, which she chairs, had discussed both a rate hike and a reduction, as the economic outlook remains gloomy, with the 2013 growth forecast now lowered to 1.9 percent from 2.O. The Reserve Bank also revised expectations for the next two years to 3.0 percent and 3.4 percent respectively. A rate hike would be difficult to justify when there is little evidence of demand-related pressure on the economy, said Standard Bank analyst Razia Khan, noting that pushing rates higher would also not be sufficient to prevent rand weakness. "The underlying growth picture may be even weaker than previously thought, and a substantial negative output gap persists," Khan said. "Monetary policy will have to remain accommodative."