The worst is yet to come for South Africa

South Africa is yet to feel the full effects of the conflict in the Middle East, with the real impact set to hit in the coming months as the war drags on. 

This is because businesses will no longer be able to absorb rising costs due to the increased length of the war, resulting in those costs being passed on to the consumer in the form of rising prices. 

Stanlib chief economist Kevin Lings explained that this will create an inflationary shock and be a point of concern for the Reserve Bank, with inflation likely to stay higher for longer. 

What was set to be a temporary blip on the bank’s journey to stabilising inflation at 3% is likely to become a running battle to get it back to those levels. 

This means that interest rates are likely to be raised sharply and held at a higher level for longer before any relief can be considered. 

Lings told 702 that much of the focus has been on rising petrol and diesel prices, which have an outsized impact on South Africa’s inflation data as they are directly included in the calculation. 

“That is fairly mechanical, and it is likely in the next two months to push inflation from the current 3.1% to over 5%,” Lings said. 

Beyond the next few months, much depends on how long the Strait of Hormuz is closed and how much relief the government can afford to give South African motorists. 

Old Mutual Investment Group (OMIG) believes the National Treasury can extend the current R3 cut to the General Fuel Levy for up to six months if it uses additional revenue from mining exports. 

However, the Treasury’s cautious approach and desire to ensure South Africa’s finances are not derailed by the conflict will mean the relief is unlikely to be extended for that period. 

Lings explained that the phased withdrawal of the government’s petrol price relief will potentially see prices rise further, pushing inflation well beyond 5%. 

“The critical question is how much of this will get passed on to other parts of the economy. All we are witnessing now is the initial impact,” Lings explained. 

“This is substantial, but there is a risk of worse consequences in the coming months as we are now in the third month of this war.” 

When it started, many thought it would last for only a couple of weeks or a month before US President Trump sealed a deal with the Iranians. 

“That would have been a bit of a shock that could have been absorbed. We are now into the third month, and as soon as you get to that length of time, there is a real risk these costs are passed on,” Lings said. 

“Companies cannot absorb all of this and then you get second-round effects. Then, inflation can go even higher and stay higher for longer.” 

“We have not even started to see the impact on our inflation data. It is all ahead of us.” 

The storm is coming

The sharp rise in inflation will result in the Reserve Bank taking action, with it likely to hike rates in response over its next few meetings. 

Governor Lesetja Kganyago has said the bank remains committed to ensuring inflation is brought back to the 3% target after the initial shock. 

“We cannot offer certainty about our next steps. Instead, we want to maximise certainty about where inflation is going – specifically, that it is going back to the 3% target,” Kganyago said.

Lings explained that the Reserve Bank is known for being cautious and is one of the best-run monetary policymakers in the world. 

The bank will not be willing to give up the gains it won in reducing the inflation target to 3% and bringing down expectations to that level. 

It will also not be comfortable with inflation remaining above 5% for a prolonged period of time, with it likely to act before it becomes entrenched. 

“We have made excellent progress in getting inflation down to 3%. This conflict has come at a very unfortunate time, with the Reserve Bank wanting to cement expectations at that level,” Lings said. 

“The problem for the Reserve Bank is that you can’t just leave the fuel price increases alone because it does risk spreading into other categories where inflation can become more sustained.” 

Lings explained the bank typically likes to look through the first-round effects of a fuel price hike to get data on whether other prices in the economy are being impacted. 

Once other goods and services begin rising, inflation becomes harder to tame and bring back to appropriate levels as those prices become entrenched. 

“As the Reserve Bank, you are almost forced to act to show that you are keeping inflation under control and to bring expectations back down,” Lings said. 

“The timing of when you act is critical. The general thinking is to wait a little bit to see if rising costs are being passed on, but don’t wait too long because then it could all be passed on and will be hard to get under control.” 

Lings said the Reserve Bank is likely to react early given its conservative nature, with it preferring to avoid any chances of inflation being entrenched at a higher level.