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South Africa’s economic outlook has improved, although growth
should stay below potential output for “some time”, posing little threat to
domestic inflation, its central bank said on Thursday.

Developments in the euro area – a major trading partner where
sovereign debt worries are growing, sparking global risk aversion – are a risk
to growth and may also hit the rand currency, the Reserve Bank (SARB) added in
its latest Monetary Policy Review.

Africa’s biggest economy pulled out of recession in the third
quarter of last year and the recovery appears to be gathering pace, with data
this week showing annual retail sales rose for the first time in more than a
year, signaling households are starting to spend again.

Consumer spending was the main driver of average 5 percent
annual growth in the five years before the credit crisis, but it has been the
slowest to rebound as banks cut lending and more than one million jobs were
lost, hurting households’ finances.

The central bank said in the review – released twice a year –
that domestic expenditure appeared to be recovering, while manufacturing output
continued to improve.

This, though, did not pose a threat to inflation, as firms
continue to produce below maximum capacity.

“Despite the more favourable growth outlook, the output gap is
expected to remain positive for some time,” it said. The bank has in the past
estimated potential growth at 4.5 percent.

The SARB forecast the economy would grow by 3.7 percent
quarter-on-quarter and annualised in the first three months of this year, and
by 3.2 percent in the second quarter.

It recently raised it prediction for expansion in 2010 to 2.7
percent from 2.6 percent – roughly in line with economists’ expectations.
Statistics South Africa is scheduled to publish first quarter growth data on
Tuesday.

Euro risks

The bank warned the recovery could be damaged by the debt
problems in the euro zone, with austerity measures dampening growth in some
economies and, ultimately, trade.

“The growth performance will also be affected by the performance
of the global economy and the risks posed by developments in the euro area,” it
said.

Another global crisis, and accompanying risk aversion, may hit
the rand, lessening the impact its relative strength has had on containing
inflation.

The central bank said its policy committee had considered the
rand a major contributor to the favourable outlook for inflation, but
recognised it was volatile and subject to external factors, such as risk
appetite.

“The reaction of the rand to the developments in the euro area
demonstrated that the positive impact of the rand on the inflation outlook was
contingent on developments in the euro area and general risk aversion,” the
central bank said in the review.

The rand had held onto last year’s nearly 30 percent gain
against the dollar, supported by strong gold and platinum prices and the lure
of high interest rates. It has weakened sharply this month as fears Greece’s
sovereign debt woes may spread to other European countries prompted investors
to cut back on riskier investments in emerging markets.

The rand fell to 8.0806 versus the dollar on Thursday, a
six-month low and a fall of almost 4 percent, compared with around 7.30 in
early May. At the height of the global financial turmoil in late 2008, it fell
to 11.88 to the dollar.

The SARB reiterated its favourable outlook for inflation, forecasting
targeted CPI to trough at 4.7 percent in the third quarter, and stay inside the
3 to 6 percent band until the end of 2012, when it is seen at 5.3 percent.