South Africa's sharply weaker rand and a severe drought pose significant risks to the inflation outlook and have further complicated monetary policy, central bank deputy governor Daniel Mminele said.
Despite weak growth and the lack of demand pressures, inflation remains high, partly due to a rigid labour market, Mminele said in a speech made in London this week and later posted on the bank's website.
The South African Reserve Bank will conclude its first policy meeting of the year on Jan. 28, and some analysts are predicting an interest rate hike to curb inflation pressures caused by a sharp depreciation in the rand.
The bank's monetary policy committee (MPC) hiked rates by 50 basis points last year, balancing the need to contain price pressures without constraining a struggling economy, which is expected to grow 1.5 percent at most in 2015.
The rand has weakened as much as 18 percent against the dollar since mid-December, a free-fall triggered by President Jacob Zuma's firing of the finance minister and on concerns about the global impact of weak growth in China.
"Rand depreciation remains a significant source of risk for the South African economy," Mminele said, noting that the local currency had underperformed its emerging market peers.
"In general, risks to the inflation outlook for 2016 remain tilted to the upside and have recently deteriorated further."
Wage increases not linked to productivity and the shortage of skilled workers also meant that average salary expectations remained above current and expected inflation, Mminele said.
The impact of the drought ravaging southern Africa on food prices was expected to outweigh the effect of lower global oil prices.
"Looking ahead, domestic constraints, exchange rate developments, the domestic drought and tighter financial conditions pose significant risks to the inflation outlook," Mminele said.
South Africa is also vulnerable to global economic and financial markets developments and the opening weeks of 2016 suggest monetary policy has been complicated, Mminele said.
"Risks will require close monitoring as we move deeper into 2016, and preparedness to take decisive action within our flexible inflation targeting framework," he said.
"The MPC will need to assess very carefully whether the current monetary policy stance remains appropriate."