South Africa's economic growth in the first quarter of this year may be at its lowest in six years, but this will be little comfort for the central bank, as the country's output gap remains positive and adding to inflation.

Global analysts Lehman Brothers feel that as the output gap in South Africa is still positive it drives inflationary pressures, and thus another hike in interest rates is still on the cards in June.

An output gap is an economic measure of the difference between the actual output of an economy and the output it could achieve when it is at its most efficient. A positive output gap is thus when actual output is more than full-capacity output. An output gap, either positive or negative, indicates some form of inefficiency i.e. overworking or under-working of resources. Of concern to SA's policymakers is that a positive output gap should lead to inflation as production and labour costs rise.

"Given our estimate of potential GDP at 3.7 percent, these growth data mean the output gap is still positive and still driving core, demand-side, inflationary pressures in the economy. As such, it should provide little comfort or help to the South African Reserve Bank (SARB) in its battle against inflation," says SA analyst from Lehman Brothers, Peter Attard Montalto.

'Extraordinary action'

"We continue to look for a 50-basis-point hike at the 12 June Monetary Policy Committee meeting as our baseline, though given recent rhetoric from Governor Mboweni of the need for 'extraordinary action' to fight inflation the chances of a 100-basis-point hike seem non-negligible," he adds.

In data released on Tuesday, SA's GDP growth was reported at a lower 2.1 percent from 5.3 percent in the fourth quarter of last year – the lowest growth since the third quarter of 2001.

Montalto notes that a few subcategories like agriculture surprised, but the electricity crisis dampened mining and manufacturing.

However, he notes surprises in retail and construction growth.

"The former increased from 3.4 percent year-on-year to 3.7 percent year-on-year, even though the monthly numbers for Q1 declined from 2.3 percent to 1.2 percent year-on-year. The SARB may well look at this figure in particular given the pressure on it not to hike rates given the squeeze on the consumer from the 450-basis-points of hikes this cycle," he says.

A similar story also occurred in construction, though this may well be picking up a faster acceleration in investment from the public sector and World Cup-related building.

South African CPIX inflation is out on Wednesday and this will add further grist to the debate on whether a more intense increase in interest rates is needed in light of the slowing economy.

The SARB is not in an enviable position either way, as the growth protagonists will be complaining bitterly if rates go up much further, saying this will lead to a recession. But if non-food and non-oil inflation continues to rise and the output gap persists together with higher wage demands, the SARB will see it as a failure in terms of their mandate to fight inflation in the face of second- and third-round effects.

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