By: Mamello Matikinca-Ngwenya, Siphamandla Mkhwanazi, Thanda Sithole, Koketso Mano
The Middle East boiling pot: A key risk to our outlook
It has been a year since the most recent tension between Israel and Palestine broke out. Contrary to what many would have hoped, tensions have flared up and risks of further escalation are material. Israel has not been battling Hamas alone but Hezbollah and the Houthis as well. On occasion, Iran has directly entered the arena and the world now awaits Israel's response to the latest Iranian missile attack. Fears are that it could target Iran's oil infrastructure, removing nearly 2 million barrels per day (mbpd) from global oil supply. There is a likelihood that spare capacity from OPEC countries, predominantly Saudi Arabia, would easily be able to bridge the gap. However, the greater worry is, what if they were also affected?
In October 2023, the World Bank ran a few scenarios based on historical experience. In their estimates, a small disruption scenario, which would remove between 0.5 and 2 mbpd of global oil supply, comparable to the supply disruption observed during the Libyan civil war in 2011, could see prices rise by up to 13% initially. A medium disruption scenario would reduce global supply by 3 to 5 mbpd, comparable with the Iraq war in 2003, and the knee-jerk reaction could see prices lift by up to 35%. A large disruption scenario would hit global oil supply by 6 to 8 mbpd, comparable to the Arab oil embargo in 1973, and prices could rise by up to 75%.
Once again, these scenarios would be relevant should OPEC's spare capacity not be readily available to the market, for example, if the Strait of Hormuz were affected, which is currently viewed as a low probability. Another important caveat is that the impact on oil prices and inflation depends on the starting point and how much risk premium has already been added to market prices. Current trends suggest that a major oil disruption could drive global inflation higher than baseline projections by approximately one percentage point.
The United States (US) is less sensitive to oil price shocks. As a rule of thumb, a $10 lift in oil could lift inflation by 0.2% in a year. Research by the Dallas Fed (2023) shows that a 20% oil price shock can lift consumer gasoline prices by 10% (oil makes up half of gasoline prices) and headline inflation by 0.3%. They find no significant presence of second-round effects and the variation in both short- and longer-term expectations are little explained by an oil price shock.
In South Africa (SA), a $10 increase in oil prices could add approximately 0.5ppts to headline CPI, given the 4.82% weight of petrol, all else equal. This is purely a direct fuel impact and there should be second-round effects. The SARB Quarterly Projection Model estimates that a temporary 10% increase in fuel prices should lift food inflation (17.14% weight) by up to 0.4ppts and core inflation (74.41% weight) by 0.2-0.3ppts in a year's time. In total, such an impact would potentially result in nearly 0.7ppts added to headline inflation over a year.1 The impact would be compounded by a weaker rand as risk sentiment worsens.
This would result in less interest rate cuts over the medium term. Importantly, government could intervene by forgoing the general fuel levy, like in 2022, which could reduce the impact on inflation. However, the adverse spillover to fiscal policy could mean that macroeconomic stability leans more on monetary policy.
Ultimately, this risk is pertinent to our expectation that inflation will remain below 4.5% over the next year and interest rates will be cut in increments of 25bps until the May 2025 monetary policy meeting. While we witness the Middle East conflict unfold, it is important to keep such risks in mind.
1 The Basic Fuel Price is about half of the total pump price. Therefore, a $10 oil price increase would lift the petrol price by around 5%, and the estimated fuel and core inflation impact would be scaled down by half.
Week in review
Gross foreign exchange reserves rose to $63.6 billion in September, up from $63.2 billion in August. This increase was driven by a $498 million rise in gold reserves, which reached $10.7 billion, supported by higher gold prices. However, foreign exchange reserves saw a slight decline, reflecting payments made on behalf of the government.
Mining production, not seasonally adjusted, increased by 0.3% y/y in August, following a revised 1.0% y/y contraction in July (previously -1.4% y/y). The outturn exceeded Reuters' consensus, which had anticipated a 2.1% y/y contraction. Excluding gold, output rose by 1.1% y/y. On a seasonally adjusted basis, mining output surged by 2.9% m/m, more than offsetting the 0.8% decline in July. However, output was still down by 1.4% over the three months ending in August, signalling that without sustained monthly growth, the mining sector could potentially weigh on GDP in 3Q24.
Manufacturing output, not seasonally adjusted, contracted by 1.2% y/y in August, following a revised expansion of 1.6% y/y in July (previously 1.7% y/y). The outcome was slightly worse than Reuters' consensus prediction of a moderate 0.5% y/y decline. Seasonally adjusted manufacturing output fell by 0.6% m/m, partially offsetting the downwardly revised 1.6% monthly expansion in July (previously 2.1%). The decline in monthly output was reflected in the manufacturing PMI business activity index, which fell deep into contraction, reaching 38.9 points in August. However, this index rebounded to 50.7 points in September, indicating a potential recovery in monthly output. For the three months ending in August, output was flat at 0.1%, but September's output is likely to show growth.
Week ahead
The upcoming week is limited on data releases. On Wednesday, retail sales data for August will be released. In July, volume sales continued their positive streak, recording 2.0% y/y - a fifth consecutive month of expansion. Nevertheless, this marked a significant deceleration from the previous month's robust 4.1% y/y growth. Month-on-month, volumes declined marginally by 0.2%, partially reversing the 1.6% growth in June. All but two categories saw an increase in annual volumes, likely aided by declining fuel costs, uninterrupted energy supply since March, and recovering consumer sentiment.
The key data in review
| Date | Country | Release/Event | Period | Act | Prior |
|---|---|---|---|---|---|
| 7 Oct | SA | Gross foreign exchange reserves $ billion | Sep | 63.6 | 63.2 |
| 10 Oct | SA | Mining production % m/m | Aug | 2.9 | -0.8 |
| SA | Mining production % y/y | Aug | 0.3 | -1.0 | |
| SA | Manufacturing production % m/m | Aug | -0.6 | 1.6 | |
| SA | Manufacturing production % y/y | Aug | -1.2 | 1.6 |
Data to watch out for this week
| Date | Country | Release/Event | Period | Survey | Prior |
|---|---|---|---|---|---|
| 16 Oct | SA | Retail sales % m/m | Aug | -- | -2.0 |
| SA | Retail sales % y/y | Aug | -- | 2.0 |
Financial market indicators
| Indicator | Level | 1 W | 1 M | 1 Y |
|---|---|---|---|---|
| All Share | 85,392.82 | -1.2% | 4.6% | 15.6% |
| USD/ZAR | 17.50 | 0.0% | -2.4% | -7.0% |
| EUR/ZAR | 19.14 | 0.8% | -3.1% | -4.2% |
| GBP/ZAR | 22.87 | -0.1% | -2.5% | -1.3% |
| Platinum US$/oz. | 967.15 | -2.4% | 3.1% | 9.3% |
| Gold US$/oz. | 2,629.48 | -1.0% | 4.5% | 40.3% |
| Brent US$/barrel | 79.40 | 2.3% | 14.8% | -7.5% |
| SA 10 year bond yield | 9.80 | -0.2% | -0.6% | -15.6% |
FNB SA Economic Forecast
| Economic Indicator | 2021 | 2022 | 2023f | 2024f | 2025f | 2026f |
|---|---|---|---|---|---|---|
| Real GDP %y/y | 1.9 | 0.7 | 1.0 | 1.9 | 1.9 | 2.2 |
| Household consumption expenditure % y/y | 2.5 | 0.7 | 1.4 | 2.3 | 2.1 | 2.4 |
| Gross fixed capital formation % y/y | 4.8 | 3.9 | -0.8 | 5.4 | 3.9 | 5.3 |
| CPI (average) %y/y | 6.9 | 6.0 | 4.5 | 4.3 | 4.7 | 4.5 |
| CPI (year end) % y/y | 7.2 | 5.1 | 3.4 | 5.0 | 4.6 | 4.5 |
| Repo rate (year end) %p.a. | 7.00 | 8.25 | 7.75 | 7.00 | 7.00 | 7.00 |
| Prime (year end) %p.a. | 10.50 | 11.75 | 11.25 | 10.50 | 10.50 | 10.50 |
| USD/ZAR (average) | 16.40 | 18.50 | 18.20 | 17.50 | 18.20 | 18.80 |
