From bad to much worse for interest rates in South Africa
Not only are interest rate cuts in South Africa increasingly unlikely, but the market is now also predicting a significant rate increase.
The outlook on inflation has taken a dramatic turn following the United States and Israel’s attacks on Iran, which resulted in retaliatory strikes from the Middle Eastern nation and the closure of the Strait of Hormuz.
Markets had previously seen between two and four rate cuts from the South African Reserve Bank (SARB) over the next 18 months, with inflation seen as being under control.
However, the three-month forward rate beginning a year from now has moved from pricing in three cuts to pricing in four hikes.
The Middle East conflict, however, has seen the price of Brent Crude oil climb by around 90% since the start of the year, while the rand has weakened to around R17.20 to the dollar.
“Price is not the only concern: if the crisis persists, domestic fuel availability could also become a problem,” said Ashburton Investments Head of Fixed Income Albert Botha.
“South Africa’s strategic petroleum reserves currently stand at 7.7–8 million barrels, far below its 45-million-barrel capacity, having never recovered from the 2016 reserve sales that the High Court later ruled to be corruption.”
This vulnerability is compounded by a sharp decline in domestic refining capacity, which has declined by around 50% since 2010.
This makes South Africa more dependent on refined fuel imports and less able to absorb shocks to supply and shipping.
On top of this, local cost pressures will be exacerbated by large electricity price increases, with NERSA approving increases of 8.76% for direct customers and 9.01% for municipalities.
In terms of labour, Eskom workers are seeking a 12% wage increase, while the minimum wage has increased by 5% from 1 March.
Nevertheless, food and fuel are the largest near-term drivers of inflation. South Africa imports over 80% of its fertiliser, making it highly exposed to global price disruptions.
The growth outlook in South Africa has also weakened, with gold down 20% from its peak, tourism likely to soften as airfares rise, and key hub routes face disruption.
Agricultural output will also face pressure from higher energy and fertiliser costs. These effects have significantly affected the outlook for interest rates.
The three-month forward rate beginning a year from now has moved from pricing in three cuts at around 6.07% to pricing in four hikes at 7.90%.
Botha said this marks a 183-basis-point shift since 17 February, and paints a worrying picture for the path of interest rates in South Africa.
Wait and see
These developments make the job of the Monetary Policy Committee (MPC) far tougher, with its next interest rate decision due this Thursday, 26 March.
Botha said a few decisions remain likely.
“First, the near-term inflation forecast will be revised upward, even as the projection for end-2027 is likely to remain close to the 3% target,” he said.
“Second, growth expectations will be lowered, weighed down by energy and fertiliser costs and by broader economic uncertainty.”
Finally, the policy rate will likely remain unchanged at 6.75% this week, even if the crisis unwinds as quickly as it escalated, as most central banks are in a wait-and-see mode.
Inflation is currently around the new 3% target, but Botha said the MPC has been conservative in recent meetings, and a pause now would buy more time.
“Uncertainty is the defining condition of our outlook, a hallmark of the second Trump term, and South Africa must, unfortunately, watch and absorb the consequences of events unfolding in the Middle East.”
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