South Africa's inflation risks are skewed to the upside, with cost-push pressures and the sharp depreciation of the rand posing the primary threats to the outlook, the Reserve Bank said on Tuesday.
In its sixth-monthly monetary policy review, the central bank said downside risks stemmed from potential contagion from the euro zone debt crisis and its impact on global economic growth.
It was ready to act appropriately whatever the outcome, it added.
Uncertainty regarding future developments in cost-push pressures and the exchange rate pose an upside risk to the outlook, which more than offsets the downside risks from possible contagion effects from the European crisis, the Bank said.
The bank's Monetary Policy Committee (MPC) left interest rates at three-decade lows at its sixth and final meeting of the year earlier this month despite signs the local economy is struggling. Inflation risks were its main reason for the decision.
While the MPC viewed these risks overall to be skewed to the upside, the committee is aware of the dangers of a disorderly resolution of the (euro zone) crisis and the systematic implications for the global and domestic economy and remains ready to act appropriately should the need arise, it said.
The rand has shed 21 percent against the dollar since the start of the year, mainly due to investors dumping riskier emerging market assets for fear that the debt crisis in some European countries will spread.
The Reserve Bank noted that South Africa's domestic recovery remained hesitant and confidence was low, with subdued demand expected to keep core inflation - which excludes food, petrol and energy prices - contained.
It expects targeted CPI to breach the top of its 3-6 percent band in the last quarter of this year and peak at 6.3 percent in
Movements in oil prices, electricity prices or the exchange rate of the rand that differ from those assumed for the forecast will impact on the central projection, it said.
The bank's inflation forecasts assume annual electricity price increases of 17.3 percent in the third quarters of 2012 and 2013.
Inflation expectations need to remain well anchored around a sound inflation target to ensure that temporary shocks have minimal effects on inflation or the economy more generally, it said.