The war in the Middle East has set the proverbial cat among the inflation pigeons, and the South African Reserve Bank now has to contend with an inflation shock. However, it is not clear that it will have to raise rates. The harrowing impact of the Russia-Ukraine war on inflation and interest rates is fresh in people’s minds, but this is not the template for policy this time around.
In January the Bank expected inflation would average 3.3% in the fourth quarter of this year. It rose to 3.9% at its most recent meeting. Polled forecasters see the number at 3.5%, close to my forecast of about 3.6%. The inflation outcome is highly uncertain, reflecting the uncertainty of the oil price path and its transmission to other goods and services. However, inflation will undoubtedly be further from the bank’s 3% target at year-end, complicating the interest rate path.
After Russia invaded Ukraine in February 2022 the inflation outlook deteriorated materially. In January that year the bank expected inflation would end the year below its then-target, 4.3%. In fact, inflation averaged 6.8% in the fourth quarter of 2022, 250 basis points above prewar forecasts.
Markets priced in an additional 225 basis points in hikes into the tightening cycle in the aftermath of the shock, and the Reserve Bank hiked rates by a stomach-churning 425 basis points to 8.25% in the middle of 2023. It is early days, but there are reasons to believe that even if Brent oil prices remain above $100/barrel, this shock will elicit a less harsh response from the Bank.
At last month’s monetary policy committee meeting the Bank left the repo rate unchanged at 6.75%. Before the war it was widely expected that the repo rate would be lowered to 6.5% at the March meeting and lowered at least once more to 6.25% before year-end. Markets are now pricing in two hikes this year, reflecting a 125 basis point hawkish swing in the forecast for the repo rate.
This view is more modest than how 2022 played out but it is likely to remain overly pessimistic. The inflation shock could be more measured this time around. Brent is about 35% higher than the prewar baseline, compared with a 70% rise in 2022. Oil price inflation dislocates 50-100 basis points, which I suspect the central bank can look through.
In February 2022 inflation was at 5.7%, 120 basis points above the 4.5% inflation target. This time around the shock finds inflation at the 3% inflation target. This is critically important as it suggests the threat of the shock to policy credibility will be much lower than in 2022.
Moreover, policy is calibrated differently this time around. In 2022 the repo rate, at 4%, was 170 basis points below inflation and monetary policy was accommodative. This shock found the repo rate, at 6.75%, 375 bps above inflation and policy is restrictive. This policy setting is likely to provide some cover for the Bank compared with 2022.
The policy calculus in 2022 was also highly influenced by what other central banks were doing. When Russia invaded Ukraine inflation was rising globally and the major central banks were unresponsive as they expected inflation to be “transitory”. Post the oil price shock the Federal Reserve raised rates by 525 bps into the middle of 2023, raising the cost of dollar funding. The Reserve Bank had no choice but to go along.
The Bank sounded cautious at its monetary policy committee meeting in March, but we suspect that caution might not extend to raising rates, though it might be enough to put off the expected cuts for later at this stage, instead of hiking.
• Lijane is global markets strategist at Standard Bank CIB.
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