Reserve Bank faces oil shock dilemma as inflation fight collides with SA’s recovery

The South African Reserve Bank (Sarb) has been successful in curtailing observed inflation and anchoring inflation expectations lower. The Bureau for Economic Research’s inflation expectations are currently around 3.7% over one-year, two-year and five-year time horizons, while Bloomberg consensus forecasts for inflation are around 3.3% in 2026 and 2027 respectively.

Sarb has chosen a path that carefully considers a combination of local and global macroeconomic conditions in monetary policy setting, and its uncompromising approach has been well received. To some extent this has been reflected in lower government bond yields over the past 21 months – alongside political stability (in the form of the Government of National Unity), a momentum build in SA’s structural reform programme, fiscal consolidation and rebuilding of fiscal credibility, and improving monetary policy credibility, among others.

SA asset allocators faced two key questions at the onset of the year: First, is there room for government bond yields to decline further? And, second, why has this rally in government bond yields (a proxy for the risk premium on SA assets) not filtered through into SA Inc equities? This, bearing in mind that SA Inc Equities continue to trade at a discount (12-month forward price/earnings multiple) due to lousy economic growth outcomes and mediocre expectations.

Statistics SA recently released GDP growth numbers for 2025, which were again uninspiring at 1.1%. This is not materially different to Russia’s expected growth of 0.9%, but sizeably below expected average BRIC (Brazil, Russia, India, China) growth of between 3.5% and 3.7% and average broad emerging market expected growth of 3.7% to 4.1% in 2025.

The ongoing and escalating conflict in the Middle East presents an “interesting” conundrum for SA monetary policy setters and potential growth outcomes based on the monetary policy response and how the combination of the conflict and monetary policy setting affects local and global economic activity.

It is well known that SA imports most of its oil and has negligible strategic oil reserves, and therefore local inflation conditions are vulnerable to global oil prices.

For consumers, fuel makes up approximately 4% of the inflation basket, therefore a 10% rise in fuel prices could add about 40bps (0.4 of a percentage point [pp]) to inflation. This is not materially different from Sarb’s own modelling, which finds that a 10% change in the oil price has a peak effect of 0.3pp on inflation. To put it into context, if the inflationary impact is persistent, and the current Bloomberg consensus average inflation forecast for 2026 is 3.3%, then inflation will settle closer to or above 3.7% for the year (assuming a persistent inflationary impact).

Tolerance band

The new inflation target regime allows for a tolerance band of one percentage point on either side of the 3% target, making it unlikely for the Sarb to cut interest rates in that environment. The rise in fuel prices (in combination with a weaker rand), although volatile, has exceeded 10% already and therefore there is an elevated risk to above expected inflation outcomes.

The persistence of a higher oil price and/or weaker currency will be key. For example, the rand has moved from 16.90/USD to 16.38/USD back to 16.78/USD and Brent crude has moved from above $115/bbl to $90/bbl back to about $97/bbl at the time of writing. This increases uncertainty around the inflation outlook.

One must also acknowledge how recent rand strength has been good for the inflation outlook. Had the rand not strengthened for SA-specific reasons (and USD weakness), over the past 21-months, then the inflation outlook and fallout would be worse. The SA-specific reasons include those same reasons highlighted above that have supported government bond yields.

Sarb now faces a tricky monetary policy setting environment and intends to redraft its risk scenarios. During a time of such volatility as illustrated in the context of the large swings in the currency and Brent crude prices, it might be advisable for the bank to “look through the noise”.

Global oil price dynamics

Firstly, South African interest rate setting will not influence global oil price dynamics, although it must be acknowledged that Sarb looks beyond first-round effects to mitigate inflationary “non-transitory” second-round effects. It is our assertion that the aggregate global monetary policy response would more likely influence oil prices (i.e. the combined response of the Federal Reserve, European Central Bank, the Bank of Japan, the Peoples Bank of China, etc), but second-round effect considerations are equally key.

Should global central banks be forced to pause their cutting cycles or, like the Reserve Bank of Australia, start hiking rates again, that would probably create a demand problem. SA does not have a demand problem yet (although demand is weak), and a pause or reverse of the monetary policy setting cycle may curtail the prospects of a cyclical economic recovery in the short term.

The effect of a pause or reversal in the monetary policy stance would probably protect the rand and insulate SA from a greater inflation fallout, and perhaps keep inflation “transitory”. The SA economy has benefitted from a structural recovery and has been poised for a cyclical upturn.

There has been a lot to be excited about when it comes to SA’s economic recovery, with the Bureau for Economic Research business confidence index reaching its highest level of 47-points in 10 years for Q1 2026 (excluding the 50 points in the post-pandemic recovery). Looking at inflation effects holistically will be key, as successfully keeping inflationary effects from increased oil prices “transitory” may be more helpful in the long run.

There is some evidence from the Dallas Federal Reserve, the National Bureau of Economic Research in the US and a paper by Gago & Vale (2025) that oil price shocks have a more short-lived and temporal impact on inflation now relative to the 1970s.

Impact on inflation

The impact on inflation is also influenced by a nation’s level of external oil dependency (SA has a high level of external oil dependence) and a nation’s economic structure. For example, the Euro Area has a higher external oil dependence relative to the US, and thus the Euro Area’s inflation outcomes are more vulnerable to oil price shocks. The European Central Bank has cut rates aggressively and the policy stance is currently near neutral (the difference between inflation and interest rates), but there are risks to their inflation and interest rate outlook. However, producer inflation has been negative year-on-year recently, so the risks are somewhat contained.

A while back we found that in periods of elevated oil prices, producer inflation is typically higher than consumer inflation. This implies that producers carry the burden of oil price shocks and are unable to pass on costs. So, the challenge goes beyond consumer inflation expectations, but also to producers and the subsequent impact that probably has on the relative ability of businesses to invest and hire more people or retain people.

This could be a sad reality for the SA economy just as it is looking to move into fourth gear after a long growth drought. A policy reversal by Sarb would probably exacerbate the situation by diminishing the prospects of businesses investing (through higher financing costs) and hiring people (erosion of spending allocations).

Sarb has been successful in combatting inflation and building credibility around SA’s monetary policy setting. The challenge will be balancing global and local macroeconomic risks in setting monetary policy – with a careful consideration of the impact of their policy positions on SA’s growth story, gross fixed capital formation (investment) and employment outcomes.

Sarb on its own cannot influence global oil price dynamics and thus will not meaningful address inflation concerns arising from higher oil prices. The aggregate global monetary policy response to rising oil prices will probably be more important. The temporary nature of oil price shocks and their impact on inflation will be a key consideration. But the question will be asked, as it was when the global economy reopened after the pandemic and the war in Ukraine, on whether the potential inflation trajectory due to higher oil prices would be transitory.

To answer this would depend on the persistence of currency weakness and higher Brent crude prices, and the extent of expected second-round effects. DM

Osagyefo Mazwai is an investment strategist at Investec Wealth & Investment International.