More interest rate pain coming for South Africa

South Africa’s central bank suggested another interest-rate increase could be warranted this year because of the fallout from the Iran war, while highlighting risks the conflict poses to financial stability.

“The South African Reserve Bank’s Quarterly Projection Model, which pointed to rate cuts in 2026 prior to the Middle East conflict, now suggests another rate increase in 2026 following the 25-basis point increase on May 28,” the bank said in its biannual Financial Stability Review released on Wednesday in Pretoria.

At the May meeting, officials raised borrowing costs by 25 basis-points to 7%, the first hike in three years, as they cautioned that inflationary pressures had escalated since the war erupted.

The US and Israel’s attack on Iran on Feb. 28 has sent crude oil prices higher after effectively closing the Strait of Hormuz, a key passageway for a fifth of the world’s oil and liquefied natural gas supplies.

“The oil price shock is expected to continue to exert inflationary pressure, potentially prompting tighter monetary policy than before the conflict,” the report said.

“Inflation is a key consideration for financial stability. Central banks, including the SARB, that employ an inflation-targeting approach to monetary policy adjust policy rates to keep inflation expectations anchored.”

The reserve bank targets inflation at 3%, with a tolerance band of one percentage point on either side. It now sees inflation averaging 4.9% in the third quarter compared with 3.7% previously.

It said the inflationary impact on households will likely be greater the longer the conflict in the Middle East persists, and increase the risk of credit defaults and constrain credit extension.

“Changes in domestic interest rate expectations since the start of the conflict also suggest that relief for interest rate-sensitive households is unlikely to materialise as expected at the beginning of the year,” it said.

“These pressures could contribute to an increase in banks’ non-performing loans.”

The bank also cautioned that artificial intelligence models, most notably the release of Anthropic PBC’s Claude Mythos, pose a risk to the sector, with disruption threats to critical financial infrastructure and services.

“The more immediate concern is probably the vulnerability exposed by advanced or frontier AI model capability,” Herco Steyn, lead macroprudential specialist at the SARB, said.

“We essentially see the vulnerability being heightened over the short term as defensive capability catches up to match the offensive capabilities, and frontier AI models can also be used for defense purposes.”

AI poses a threat to payment, clearing, settlement and messaging systems and increases the risk of system outages, payment failures and infrastructure breakdowns, which impact the provision of essential financial services, according to the report.

“Disruptions to payment systems may constrain liquidity circulation, while outages affecting digital banking or card payment platforms can limit households’ and firms’ access to funds,” it said.

“If such incidents occur at scale or persist for extended periods, they may impede economic activity and amplify broader financial stress.”

The SARB plans to make deposit facilities available to central counterparties, which stand between a buyer and a seller of a financial instrument, by the end of 2026.

The move is designed to improve the resilience of the financial system. JSE Clear is currently South Africa’s only central counterparty, holding margin funds of 60 billion rand ($3.6 billion) to 70 billion rand.

Roughly 40 billion rand of this will move to the SARB this year, the central bank said.

South Africa’s foreign exchange reserves have grown and now stand at more than 16% of gross domestic product — the highest level recorded since data became available in the early 1960s.