Executive summary The repurchase (repo) rate was raised by 75 basis points in 2014 as part of a gradual rate-hiking cycle. This is a response to a combination of a higher trajectory for headline inflation and elevated risks to the longer-term inflation outlook. Headline inflation has been outside the target for much of the year, peaking at 6,6 per cent in May and June, before falling to just within the target range in September and October. Significantly lower oil prices and moderating food price inflation have helped the near-term headline inflation outlook. Core inflation, however, is stubbornly high, propelled by rand weakness, inertia in price and wage setting and consistently high services inflation. Inflation expectations appear stable but are above the upper end of the target range.South Africa’s macroeconomic imbalances have grown more uncomfortable. The current-account deficit is large relative to historic norms and peer countries, and has been closing only slowly. Policy adjustment through a lower inflation rate and gradual fiscal consolidation will help over time to ease the current-account deficit to more sustainable levels, while contributing to lower long-term costs of borrowing.Global financial conditions have become less hospitable for countries with large external financing requirements – a change emanating from a gradual normalisation of monetary policy in the United States (US). This process has already delivered a bumpy ride for South Africa, as it has for some other countries, with bouts of volatility (such as January 2014) interspersed with periods of uneasy calm (as in mid-2014). We cannot be sure how normalisation will proceed, or how much additional easing by the European Central Bank and the Bank of Japan will offset tightening by the US Federal Reserve (the Fed). The overall process should be protracted, with world interest rates moving higher at a slow and steady pace. Based on experience, however, it is unlikely that markets will adjust smoothly despite the best efforts of policymakers to communicate their intentions clearly. From this perspective, the rand exchange rate is likely to be intermittently volatile and could weaken further.Domestic economic performance has been disappointing, with growth forecasts for the year reduced from 3 per cent (as of November 2013) to 1,4 per cent. This reflects a series of long-and short-term supply shocks, including rising intermediate input and labour costs, costlier and less reliable electricity, and severe strikes in the mining and manufacturing sectors. Estimates of potential growth show it has fallen, and it may have deteriorated further this year given the severity of these disruptions. Commodity prices have also declined, affecting South Africa’s terms of trade. World economic growth has been subdued, owing in particular to protracted weakness in the euro area and a broad-based emerging-market slowdown. It is therefore unlikely that better export earnings will soon moderate South Africa’s external financing requirements.