Domestic growth is nevertheless poised to benefit from the improvement in the global macroeconomic environment. Supported by monetary and fiscal stimulation, economic activity in the United States, Japan and a number of other Asian countries picked up strongly. Some tentative signs of a mild recovery in the euro area also emerged in recent months. While inflation remained low in most parts of the world and the general trend in short-term interest rates remained downward until recently, both the Reserve Bank of Australia and the Bank of England have raised their official central bank interest rates in the fourth quarter of 2003.

The weakness in real output in South Africa during the third quarter of 2003 was concentrated in agriculture and manufacturing. With field crop production adversely affected by poor weather, real production volumes in agriculture continued to decline. Simultaneously, real value added in the manufacturing sector registered its third successive quarter of contraction as the recovery in the exchange rate of the rand and lacklustre world demand inhibited this sector’s output performance. In 2001 and 2002 this performance had been somewhat artificially boosted by the effect of the depreciation of the rand on the competitiveness of export-oriented and import-competing industries.

Real gross domestic final demand continued to rise briskly in the third quarter of 2003. While real final government consumption expenditure steadfastly maintained a growth rate of 4 per cent, growth in both real consumption expenditure by households and real fixed capital formation gained further momentum in the third quarter. Rising real incomes, declining interest rates and relatively stable goods prices supported this acceleration in real expenditure. However, the tempo of inventory accumulation fell back appreciably during the third quarter, possibly partly on account of stronger-than-expected demand for both consumer and capital goods.

Firm domestic demand was reflected in a brisk increase in the volume of merchandise imported. Export volumes rose less robustly, but with rising export commodity prices and an improvement in South Africa’s terms of trade the deficit on the current account of the balance of payments receded to just over 1 per cent of gross domestic product in the third quarter of 2003. The repatriation of export proceeds by South African companies, foreign direct investment inflows and other short-term financial flows contributed to a sizeable surplus on the financial account and to an overall surplus on the balance of payments. Consequently, the country's gross gold and foreign reserves rose to a level in excess of US$20 billion at the end of September, the positive net open foreign-currency position of the Reserve Bank rose further and the exchange rate appreciated further. The nominal effective exchange rate of the rand appreciated by 16 per cent in the first 9 months of 2003 and by a further 5½ per cent in October and the first three weeks of November.

The recovery in the exchange rate and the maintenance of prudent monetary and fiscal policies were reflected in a rapid reduction in inflation. Led by the prices of imported goods, which in rand terms fell back by 8 per cent in the year to September 2003, inflation in production prices and in the prices of consumer goods moderated significantly. Headline consumer price inflation was also reduced by the impact of the lower repurchase rate of the Reserve Bank on mortgage interest cost. CPIX inflation, which excludes mortgage interest cost, receded to a twelve-month rate of 5,4 per cent in September 2003 – the first time since late 2001 that it had moved below 6 per cent. Subsequently, this rate declined further to 4,4 per cent in October 2003. This achievement is set to have a beneficial effect on inflation expectations and on the credibility of the inflation targeting monetary policy framework.

The average level of wage settlements for the nine months to the end of September 2003 amounted to 8,9 per cent. However, quarterly surveyed formal-sector employment resumed its downward trend after the employment gains of the middle quarters of 2002, suggesting that labour productivity continued to rise. Increases in labour productivity nevertheless were generally lower than before, contributing to a fairly high rate of increase in unit labour cost.

Against the background of subdued growth in real output and low inflation – even price declines in some categories of goods and services – the demand for money expanded very slowly; in August 2003 twelve-month growth in M3 fell back to its lowest level in ten years. Monetary institutions’ loans and advances to the domestic private sector rose more briskly, recording twelve-month rates of increase of around 12 per cent in recent months. Mortgage advances, instalment sale credit and leasing finance recorded firm increases, consistent with the reductions in banks’ lending rates and with the strong performance of the real-estate market and buoyant durable goods purchases. Other bank loans to the corporate sector, however, contracted in recent months as disintermediation, in which corporate entities issue bonds and other securities rather than mobilising bank finance, picked up.

The Financial Sector Charter agreed to between key stakeholders in the financial sector was released on 17 October and was generally well received. It provides for systematic progress with human resource development and Black Economic Empowerment in the financial sector.

The Reserve Bank reduced its repurchase rate by a total of 5 percentage points in four months, the latest reduction being implemented in mid-October 2003. Since actual and expected inflation declined strongly over the same period, positive real interest rates were maintained and on each occasion the Bank’s Monetary Policy Committee (MPC) satisfied itself that the interest-rate reduction would be reconcilable with the sustained achievement of the inflation target. Long-term interest rates also declined somewhat further and reached their lowest levels in 24 years.

Shares prices have risen significantly since late April 2003, despite the impact of the further recovery in the exchange rate of the rand on expected profitability in the export and import-competing sectors of the economy. Real-estate prices continued to rise strongly and property market turnover remained brisk, supported by the reductions in mortgage interest rates.

Fiscal policy became increasingly expansionary as lower tax collections from companies engaged in mining and manufacturing acted as an automatic economic stabiliser. As indicated with the release of the Medium Term Budget Policy Statement in November 2003, a more stimulatory fiscal policy stance will be maintained while remaining within the parameters of sustainability.

Following a recent review of the inflation targeting framework, the Minister of Finance and the Governor of the Reserve Bank have agreed to a number of technical refinements of the framework. These were announced on 12 November 2003, and are outlined in the accompanying table. The target is now to be met on a continuous basis. If inflation is thrown off target by a shock there is no escape from introducing steps to steer it back on track.