A nice surprise for South Africa
Markets were surprised by the South African Reserve Bank’s decision to hold interest rates at its latest meeting, letting debt holders breathe a sigh of relief.
However, early signals are emerging that the reprieve may not be long-term, and inflation will become a deciding factor at the next meeting in September.
According to Old Mutual Wealth Investment Strategist, Izak Odendaal, the SARB’s decision to hold interest rates at its 23 July meeting caught many by surprise.
“The market expected an increase, not just because of recent gains in global crude oil prices,” he said.
Many factors were pointing to a likely hike: June’s inflation data, released earlier in the week, showed that core inflation increased alongside headline inflation.
Inflation expectations from various sectors also pointed higher.
“While the increase in headline inflation to 5% in June from 4.5% in May was largely due to fuel inflation, the increase in core inflation to 4% suggests some passthrough from higher fuel prices to other goods and services,” Odendaal said.
Not only was new data showing strong indications of a hike, but forward-looking risks were also clearly in view.
Notably, food inflation risks are to the upside, given global fertiliser prices and the potential impact of a strong El Niño event, Odendaal said.
The SARB, meanwhile, faces the added complication of achieving a new 3% target.
Despite the nice surprise on the hold for debt holders, Odendaal noted that two of the six MPC members favoured an increase of 25 basis points. This means “a September hike is possible,” he said.
On the other hand, there is a case for staying on hold to assess the incoming data.
“The Reserve Bank’s policy rate remains elevated in real terms even with higher inflation, unlike [other major central banks],” he said.
“The rand has also been relatively stable throughout the Gulf war, unusually for a time of global anxiety.”
The rand has fallen sharply since the rate announcement, as markets had to price out the expected rate hike. Nevertheless, it remains under R17/$, and has shown remarkable resilience.
What determines the path ahead
Odendaal said inflation will remain the key watch going forward.
“Inflation concerns are rising again as an escalation of the US-Iran war puts renewed upward pressure on oil prices…Where things go to from here is anyone’s guess,” he said.
He noted that there are three broad possibilities:
- The United States steps up its blockade of Iran but scales back military action. This will lead to higher oil prices until Iran’s fragile economy crumbles and its leaders capitulate. It also means elevated petrol prices.
- The United States dramatically steps up military action to force the opening of the Strait of Hormuz. This would require an escalation of an already unpopular war, with no guarantee it will work.
- A renewal of negotiations, which remains most likely.
Ultimately, the situation remains uncertain and in flux.
The strategist said that central banks typically don’t respond immediately to impacts like higher fuel prices, since they are pure supply shocks.
“They care more about how fuel influences other prices, which is called the second-round effect,” he said, noting that, so far, the evidence of second-round effects has been limited.
He said that the SARB’s latest forecast shows it expects inflation to average 4% this year, a bit lower than what it expected in May.
However, it now projects that inflation will take longer to return to the 3% target than previously expected, only by the first quarter of 2028.
“This suggests that it could take a bit longer for the first rate cut to arrive,” Odendaal said.
“These projections are a bit more optimistic about economic growth this year, with the improving trend over the medium term still intact.”
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