The uncertainty in the growth outlook has increased this year and continues to rise. The new fear for the global economy is stagflation, that toxic economic environment in which low growth is paired with high inflation, making policy responses to economic crises impossible. The risk of such an outcome has increased with the intensification of the conflict between Iran and Israel in the Middle East.
The most recent war-inflicted global energy shock was in early 2022 when Russia invaded Ukraine. Oil prices climbed 75% between December 2021 and March 2022. A barrel of Brent now costs 25%, or $15, more in dollar terms than in May, with potential for even more escalation if the Israel-Iran war intensifies and threatens oil supply. In that case $90 per barrel doesn’t seem too far.
A stagflationary oil shock would be disastrous for the currency and assets across the board. The rand, which had been slowly strengthening, weakened against the dollar in the past week and a half. Share prices don’t like the grim implications for growth and are also falling. The local growth outlook, already battered by the trade war, would suffer if this oil shock manifests. GDP is forecast to grow by a pedestrian 1.1% and the risk is now that the outlook dims further.
The war could of course fizzle out and upside risks to oil prices could recede. The discussion would then return to one about prices drifting below $60 per barrel. This leaves us in the world of the proverbial two-handed economist: prices could rise 20% or fall by the same percentage. Each scenario would solicit different outcomes for growth, inflation and interest rates. Downstream of these are divergent outcomes for asset prices and currencies.
Beyond the offshore uncertainty, local policymakers have added their own. The SA Reserve Bank continues to push for the inflation target to be lowered to 3% from the effective 4.5% and the National Treasury is so far saying nothing. Monetary policy is calibrated around the inflation target, and it is a core anchor of the Bank’s monetary policy committee reaction function and market expectations of the same. Absent clarity on the inflation target, interest rate expectations are difficult to set.
To illustrate the point, the neutral policy rate in a 4.5% target regime is 7%. Under a 3% target regime it is 5.5%. Interest rates must move to reflect this. Under a 4.5% target regime the Bank has room to cut rates now. If the target is 3% it should leave interest rates unchanged for now and will have room to cut them later.
The rand and equities would behave differently dependent on the target decision. If the target is lowered, the rand could strengthen on the implied higher real rates and share prices would be depressed by the deterioration in the short term growth outlook. Keeping the target unchanged would be negative for the currency.
Predicting markets is a fool’s errand at the best of times, and all forecasts and views are covered in disclaimers. Global policy uncertainty and geopolitics have made decision-making difficult this year. The US trade war dominated the first four months of the year, and the Israel-Iran and maybe US war looms large as a risk.
Local policymakers’ indecision over the change or lack thereof in the inflation target is a small issue, but it adds insult to injury. I spend most of my time trying to say where the rand and rates are going. The job has rarely been more difficult.
• Lijane is global markets strategist at Standard Bank CIB.
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