Reserve Bank hikes interest rate for first time since 2023 as oil shock, inflation risks mount

The South African Reserve Bank has increased its key interest rate by 25 basis points to 7%, marking the first hike since May 2023. Governor Lesetja Kganyago announced the decision on Thursday, signaling growing concern over inflation risks stemming from escalating Middle East tensions, rising oil prices, and potential climate-related food price shocks.

Four members of the monetary policy committee supported the rate increase, while two preferred to maintain the current rate. This move is anticipated to raise borrowing costs for consumers and businesses already grappling with high prices for food, fuel, and electricity. Commercial banks are expected to follow suit by increasing their prime lending rates.

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Oil prices have fluctuated around 100 dollars per barrel.

The Reserve Bank highlighted that the decision was influenced by significant global uncertainty, particularly the worsening crisis in the Middle East and disruptions to the Strait of Hormuz, a vital oil shipping route. "Oil prices have fluctuated around 100 dollars per barrel," Kganyago stated, noting that higher fuel costs are contributing to inflation, which rose to 4% in April, up from 3.1% in March, primarily due to energy and services costs.

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The challenge of large and overlapping shocks would likely trigger second-round effects.

Kganyago expressed concern that initial price shocks could spread throughout the economy, impacting wages, transport costs, and inflation expectations. The bank also pointed to climate-related risks, such as severe floods in several provinces and the potential for drought due to an El Niño weather pattern, which could further pressure food prices. "The frequency of these extreme weather events underscores the threat from climate change," he added.

While the bank has revised its inflation forecasts upward, projecting headline inflation to average 4.4% this year, it has also lowered its economic growth forecasts for the next two years. Despite these challenges, the central bank acknowledged the country's resilient economic recovery, citing a recent positive outlook revision by Moody's and ongoing domestic reforms. The bank's models suggest a potential further rate hike this quarter before a gradual easing as inflation subsides.

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The frequency of these extreme weather events underscores the threat from climate change.