Bad turn for interest rate cuts in South Africa
The escalating conflict in the Middle East could present a significant risk to South Africa’s inflation outlook, which could spell bad news for interest rate cuts in the near future.
Interest-rate traders have priced in a chance of a South African interest-rate hike later this month as the Iran conflict pushed oil prices higher, reviving concerns about inflation.
Forward-rate agreements now anticipate a 6-basis-point rate increase at the March 26 policy meeting, or a 24% chance of a 25-basis-point hike.
As recently as Friday, they were pricing in almost a 30% chance of a 25-basis-point cut.
The market is also less confident of monetary easing over the rest of the year. It’s now pricing in just 15 basis points of easing by year-end, down from 39 on Friday.
Brent crude oil rose above $80 a barrel on Tuesday as the US and Israel stepped up their attacks against Iran.
That risks pushing inflation in South Africa further away from the central bank’s 3% target. The weakening rand could add to price pressures.
Policy makers “would most likely look through this if it’s a temporary shock, and not raise rates,” said Annabel Bishop, chief economist at Investec.
Persistently higher inflation, however, would force the central bank to tighten, though that is a “severe downside” scenario, she said.
The rand extended declines on Tuesday, weakening 1.2% to 16.2937 per dollar as of 12h05 in Johannesburg. That brings its two-day drop to 2.2%.
Stanlib Chief Economist Kevin Lings added that the weekend attack by US and Israeli forces on Iran, and the prospect of further escalation, introduces “substantial unknowns” for global markets.
He noted that while the timing of the strike was not entirely unexpected—given the visible build-up of US military forces and stalled negotiations—the broader trajectory of the conflict remains unclear.
“The other unknown is, is this going to broaden out and include many more countries? If that happens, this becomes a significant regional conflict,” Lings cautioned.
Threat to one of South Africa’s major inflation components
From a market perspective, he said investors are already reacting. “There’s been a move higher in some safe haven assets, particularly gold,” although he described the rise as “fairly muted”.
This is because gold prices were already elevated. Oil prices, however, have moved higher more decisively.
The key issue for South Africa is what this means for supply disruptions and, ultimately, domestic inflation and interest rates.
Lings stressed that South Africa has made significant progress in lowering inflation, with the rate currently at 3.5%, close to the 3% target.
“Getting inflation down to the 3% target is a significant achievement so far. The progress we’ve made so far, I think, has been exceptional,” he said.
However, he warned that petrol prices pose a clear upside risk. “Right now the petrol inflation rate is about -10% and that’s incredibly low,” he said.
While this has helped suppress overall inflation, it also creates a low base effect. “If there were to be a spike in the oil price or currency weakness, then you’ve got some significant upside risk — and that is clearly manifesting now.”
According to Lings, the under-recovery on South Africa’s petrol price was already around 75 cents a litre before the latest escalation.
“As things stand, we’re facing a fairly hefty price increase going into the next couple of months,” he said.
With oil prices rising further and the potential for currency weakness, “we’re looking at a meaningful escalation in a key component of our inflation basket.”
He added that if the Reserve Bank sees that a key element of the inflation numbers is starting to move up, then they may become even more hesitant to cut rates and become more conservative.
“The risk for us is that interest rates simply remain unchanged for a longer period of time and we don’t get the benefit in the short term of interest rates moving lower and therefore reducing the cost of capital.”
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