However, in the international financial markets there were signs of a change in sentiment in the second quarter of 2006 as international investors lost some of their appetite for exposure to emerging markets, resulting in the depreciation of a number of emerging-market currencies, lower share prices and a widening of the risk premia on these countries’ debt securities. South Africa was one of the countries affected, with the external value of the rand depreciating by approximately 10 per cent in the final three weeks of May and share prices falling significantly at the same time, reinforced by a decline in the prices of gold and platinum from earlier exceptionally high levels.

Real economic growth in South Africa accelerated in the first quarter of 2006 as the real value added by the secondary sector picked up significantly, buoyed by a recovery in manufacturing output, alongside brisk output growth in the tertiary sector. A discordant note originated in the primary sector, where real value added contracted in the first quarter as livestock production weakened and output volumes edged lower in gold mining and a number of other mining subsectors.

Aggregate real gross domestic expenditure recorded very strong growth in the first quarter of 2006. Real household consumption expenditure maintained a brisk pace of increase in the first quarter, while growth in real fixed capital formation gained further momentum. Real inventories rose strongly in the first quarter, restoring inter alia buffer stocks as petroleum refineries resumed normal production following the supply disruptions which developed towards the end of 2005. In the absence of further high-value military items being acquired by the South African National Defence Force in the first quarter of 2006, real final consumption expenditure by general government contracted somewhat.

The vibrant domestic expenditure was reflected in brisk imports. At the same time the country’s export performance deteriorated, resulting in a widening in the deficit on the current account of the balance of payments to 6,4 per cent of gross domestic product in the first quarter of 2006 – the highest deficit ratio in 24 years. This was despite a moderate improvement in South Africa’s terms of trade in the first quarter as the prices of certain export commodities recorded robust increases. Inflows through the financial account of the balance of payments remained more than adequate to finance the deficit on the current account, with portfolio inflows the largest contributor to the surplus on the financial account. Significant foreign direct investment and other investment inflows augmented portfolio investment in the first quarter of 2006, resulting in an overall balance-of-payments surplus and improvement in the authorities’ net gold and foreign exchange reserves.

Employment in both the private and public sectors of the economy expanded further in the final quarter of 2005, with some indications that this trend continued into the early part of 2006. While wage settlements in the first five months of 2006 remained reconcilable with the inflation target, a significant part of the workforce in the private security industry engaged in a protracted wage-related strike during the second quarter of the year.

Inflation remained well contained, both at the production and consumer price level. By April 2006 twelve-month CPIX inflation had been maintained inside the target range of 3 to 6 per cent for 32 consecutive months. Furthermore, if petrol and food are excluded from the consumer price basket on account of their volatility, the inflation in the remaining items fell marginally below the bottom of the target range in recent months. The results of surveys conducted in the first half of 2006 indicate that inflation expectations were benign, while bond yields sketched a similar picture. Nevertheless, an upward trend in food inflation started to emerge in the data from late 2005, while the depreciation of the exchange value of the rand in May 2006 provided further reason for developments in inflation to be closely monitored.

In early 2006 growth in the broadly defined money supply accelerated to twelve-month rates last observed in 1989, reflecting the vibrant domestic expenditure and income, strong wealth effects resulting from brisk increases in asset prices, and the related vigorous levels of activity in the financial markets. Similarly, the already high rates of increase in banks’ loans and advances gained further momentum in the first quarter of 2006. Growth over twelve months in mortgage advances reached 30 per cent as the real-estate market maintained strong momentum, while the other types of credit extension also recorded buoyant increases. Although there was an acceleration in the corporate sector’s utilisation of credit, the bulk of the increase in the banks’ loans and advances continued to flow to the household sector. The ratio of household debt to disposable income of households accordingly scaled new heights in the first quarter of 2006. With nominal lending rates having remained at relatively low levels over the past year, however, the household sector’s debt service burden remained fairly modest.

In the fiscal year 2005/06 the non-financial public sector recorded a cash surplus for the first time in history, amounting to 0,7 per cent of gross domestic product. The turnaround from a borrowing requirement in the previous year to a surplus was mainly due to a considerably smaller national government deficit and a larger surplus in the books of the non-financial public-sector enterprises. In turn, these were respectively related to the strength of the economy and the accompanying brisk increases in tax revenue collected by national government, and to the long gestation period before the fixed investment projects of some non-financial enterprises get underway.

Despite this disciplined fiscal setting, several imbalances and pressure points in the economy clearly worsened. In its April 2006 statement the Monetary Policy Committee warned that the risk of an acceleration in inflation has increased, but kept the repurchase rate unchanged. At its June meeting the Committee found that the inflation outlook had deteriorated somewhat as a result of higher international oil prices, the weaker exchange rate and continued high levels of consumer expenditure. Furthermore the Committee was of the view that the risks to the inflation outlook were on the upside. Accordingly, on 8 June 2006 an increase in the repurchase rate from 7,00 per cent to 7,50 per cent per annum was announced. This followed a period of 14 months during which the repurchase rate had been kept unchanged, and has also been the first increase in the benchmark rate since September 2002.