The South African Reserve Bank warned on Thursday that the country would continue to exceed the upper level of its inflation target range in the next two years if Eskom were granted annual electricity price increases of 45%.

Deputy Reserve Bank governor Brian Kahn told Parliament's Portfolio Committee on Finance the bank's central projection, made in its twice yearly monetary policy review released this week, would see inflation dipping below the six percent mark next year to 5,8% and remain relatively stable at 5,9% in 2011.

However, this was based on a projection of electricity price increases of 25% a year.

The target would probably remain in reach if electricity prices went up by 30% over the next two years, he said.

If however Eskom were granted its controversial 45% annual increases by the national regulator, "inflation would probably be outside the target range".

What was less clear to the Central Bank, was what the secondary implications of drastic electricity price increases would be.

"It is very difficult to determine how that is going to work, especially because electricity is such a pervasive input in the economy," Kahn said.

He pointed out that because the requested price increases were so big, it was likely they could have an impact on South Africans' discretionary income. This would in turn impact on the inflation rate.

Kahn said the bank thought it was unlikely it would have to re-adjust forecasts because of a 45% tariff hike, as Eskom had been under pressure to scale down its application to the National Energy Regulator of South Africa.

The Democratic Alliance said Kahn's warning that the price hikes could keep South Africa outside its target band "is clear evidence that Eskom needs to rethink the funding model of its current running costs and future capital expansion".

It said Eskom should consider other ways of borrowing the money it needs for its infrastructure expansion programme, such as borrowing or partial privatisation.

South Africa's consumer price index (CPI) inflation dropped to 6,1% in September last month, just above the top end of the target band which it has breached since April 2007. Analysts agree that further electricity price hikes, after this year's 31% increase, posed the biggest threat to the downward trend.

Kahn said the Reserve Bank's central projection was for the average quarterly CPI inflation rate to decelerate further to 6,1% for the fourth quarter of this year.

He noted that food inflation, slowed dramatically by the decrease in commodity prices, was now "pulling down" average inflation and fuel prices were no longer playing a big role.

He expected these factors to continue to put the brakes on inflation in the months to come.

The Reserve Bank's monetary policy committee said on Wednesday it was cause for concern that the inflation forecast remained so close to 6% that relatively small shocks could see another breach in the top end of the target band.

New Reserve Bank governor Gill Marcus stressed however that the bank's policy of flexibility on inflation targeting meant it was not obliged to act aggressively to contain inflation, but could act in the broader interest of the economy, which appears to be lagging the recovery of the global economy.

Marcus said this week the Bank wanted the electricity price increase to be handled in a way that did the "least harm" to the economy.