Does the oil price have economists questioning their inflation and interest-rate estimates?

‘Certainly there are risks, but we don’t know how this is going to pan out, and a higher oil price will certainly mean uplift in headline inflation numbers’: Old Mutual economist Johann Els.

FIFI PETERS: When we left for the weekend on Friday we left a Brent crude oil price at around $114/barrel. That was after it had briefly touched $120/barrel earlier on Friday.

But this morning we woke up to the shock that Brent crude had actually reached $139/barrel, close to $140/barrel – this all on concerns that the US may implement sanctions on Russian imports. These levels in Brent crude we haven’t seen since the 2008 financial crisis and, to discuss what this could mean for inflation expectations if it persists, we are joined by Johann Els, chief economist at Old Mutual.

Johann, thanks so much for your time. Many people are talking about paying R30, R40/litre at the pumps in the foreseeable future. Is this an exaggeration, or a probable reality at this stage, in your view?

JOHANN ELS: That scarily looks like a probability, but I would hesitate to go there yet. There’s lots of uncertainty around this Ukrainian conflict. If it’s a conflict of short duration that’s limited to Russia and Ukraine itself, then we might actually see quite a big reversal in this oil price pretty soon. Of course we don’t know that for a fact. But if the conflict lasts much longer or expands into Nato countries with Nato involvement, then I suppose all bets are off.

But for now I think let’s not change forecasts too rapidly yet. Let’s just warn about the potential risks. Certainly there are risks, but we don’t know how this is going to pan out, and a higher oil price will certainly mean an uplift in headline inflation numbers.

FIFI PETERS: I recall the last inflation numbers came from 5.7%, and I think that consumer price inflation has presently landed at 5.2%. When that happened, the consensus among your fellow economists, probably even yourself, was that our inflation had peaked. Just given what we have seen, not only with oil prices but also other commodity prices in the past two weeks, do you still hold that view?

JOHANN ELS: No, I don’t think we can say it has peaked. In December was at 5.9% and many of us thought that was the peak. I think we can top 6% in the short term –  over the next couple of months, perhaps – given that we’ve had a big petrol price increase in March and more is coming in April, and probably in May as well.

But the fact of the matter is that we all have limited budgets on a monthly basis. So if we have to spend more, we are forced to spend more for transport costs, petrol and so forth, we’ll spend less elsewhere. So I think the first thing that we have to acknowledge is that there are going to be big relative price changes. We’ll spend more on the essentials and less elsewhere, so the elsewhere and the other categories within the CPI basket might actually experience very low or even declining inflation rates because it will be difficult for businesses to pass on all these increases. I don’t think we are going to see a significant second-round impact of price costs rising into other prices as well.

FIFI PETERS: What is this likely to mean for the position of the Reserve Bank in raising interest rates because, before the Ukraine crisis really blew out of control, there was an expectation regarding the US Federal Reserve that, when it does raise interest rates later on this month, 50 basis points was a done deal. Now we’ve seen some of those forecasts coming back a bit because of the sensitivity at this stage to ensure that yes, you do protect the economy from rising prices, but you also protect the economic recovery. So, in South Africa’s case, how is the Reserve Bank in your view likely to move forward in this very uncertain environment?

JOHANN ELS: A very good question. Certainly I think that it will continue to lift interest rates gradually, but I don’t think it is going to be lifting them significantly. They are obviously worried about inflation expectations running away with headline inflation rising, but with inflation excluding petrol still around 4.3%, and core inflation excluding food and energy even lower, there’s no need yet to start raising interest rates significantly faster. But I think there’s also this, as we see with the US, that central banks will gradually become more worried about the economic impact of this conflict. As I said, the longer it lasts, there will potentially be a more negative impact on growth globally and in South Africa.

So I think the Reserve Bank will continue to hike, especially in the first half of this year, but they will be careful to watch the potential impact on the economy as well.

I still stick with my forecast that by the end of next year interest rates in South Africa will still be below what they were in February 2020 –  in other words before we saw the emergency rate cuts for Covid.

FIFI PETERS: Which is what – just remind us?

JOHANN ELS: Now you’ve asked me something that I don’t know exactly. I don’t know exactly what the level was. But a slow increase. In other words, three more rate hikes of 25 basis points this year, and another two next year. So that’s a slow hiking cycle.

FIFI PETERS: All right. Apologies for that, Johann. Just one last question, though. On growth every other day we are hearing of talks going on with the West and Europe about increasing sanctions and applying extra pressure to squeeze Russia’s economy. In the event that Russia’s economy does plunge into a recession, what does that mean for South Africa?

JOHANN ELS: Very little, fortunately. Russia is very small in the bigger scheme of things, especially in our trade with them. As part of the global economy, Russia is not that big.

Unfortunately for South Africa, where the potential negative could … come from is from significantly higher oil prices. Of course that is a negative, because it impacts on consumer spending, it impacts on business spending. So it is potentially negative in terms of spending and loss of economic growth.

But fortunately on the other side of the same coin, we’ve had the prices of those commodities that we export – and the big ones are gold, platinum group metals, iron ore and coal. Those prices have increased significantly as well. So the net impact on our balance of payments and the net impact on our economy will likely be very little thus far, given that that our exports are keeping track with our import prices that we have to pay for oil now.

FIFI PETERS: Johann, thanks much for your time. A bit of comfort there, just in terms of the likely impact on the economy being very marginal. But I think we all continue to follow the developments that just seem to be happening so quickly. Johann Els is chief economist at Old Mutual.

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Things now make a classic case blowing out the old inflation:interest rate theories. When externalities drive prices upward, increasing interest rates will simply ADD to inflation.

Many economists have questioned the old concept that linked interest, inflation and unemployment. I challenge somebody to find an economy with high interest, low unemployment. The norm is high unemployment, high inflation, high interest rates. Of those, central banks have one tool being interest and low always wins. Within reason – Zim’s problems will not disappear if their central bank goes for 1% rates…

End of comments.

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