Middle-East conflict ups ante on oil prices, inflation, rates

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SIMON BROWN: I’m chatting  with Isaah Mhlanga, chief economist and head of research at RMB. Isaah, I appreciate the time today. The outbreak of war between Israel and Hamas is of course a huge human tragedy, but it also ups the ante in a world which was dealing with macroeconomic complications already in terms of interest rates, inflation, and we’ve passed the pandemic. But it really does add significant potential extra risk.

ISAAH MHLANGA: Absolutely, Simon. I think the context within which it happens from a geopolitical, geo-economic and perhaps even geostrategic perspective was already more complex. We had Brics expanded within the new countries that have been invited. You have major oil producers from the Middle East, inclusive of Iran, which means from a South African perspective it would have to engage with all those Brics members.

But now if we have the war that has broken out between Hamas and Israel and the potential for the war to broaden to other countries within the Middle East, the [thing] that we’re particularly worried about is if Iran gets drawn into the war, the major oil producer now part of Brics, means we’ll have to engage as South Africa with it at some point in time. That just increases the risk for South Africa specifically, but it also increases the risk from a global perspective in terms of the potential for increases in oil prices that would add to higher inflation.

If we just dial back to the war in Ukraine with Russia, we didn’t understand initially, but the moment it had an impact on energy markets everybody understood the impact of that war, [both] on inflation and central banks. That’s something that is also starting to happen now. Until Iran gets drawn in too, that risk remains low. But it’s a risk that is live that we are watching.

SIMON BROWN: I take your point, it’s a live risk. It’s not there yet, but it could happen. Obviously Iran is a big oil producer. Even Saudi Arabia is right there, and a massive oil producer. The direct hit is energy costs. That of course plays into inflation. That then, of course, brings us back to interest rates and potential growth. The worst case here is exceedingly severe – aside from what’s happening on the ground in Israel.

ISAAH MHLANGA: Absolutely. Central banks currently are signalling that interest rates will be higher for longer. Even before the outbreak of this war they had been signalling the same, which means the elevated risks that are now coming from an energy perspective will just reinforce that view.

Potentially, though we see oil prices continue to remain elevated – remember, about 7% [up] before the breakout of the war; they have come down a bit, but they haven’t recovered fully – that means that will still filter through into the fuel price in oil- importing countries.

But if we were to see an increase in the oil price, say to $95 to $100 per barrel, that will be inflationary, which means we would move from a higher-for-longer regime that is being signalled by central banks to an actual increase in interest rates from where we are. We thought the US Fed had peaked in terms of interest rates, and in consequence the South African Reserve Bank had also peaked at 8.25%. But if we were to see the materialisation of that risk, it would imply that we can see an actual increase in interest-rates relative to a hold from where we are.

SIMON BROWN: And obviously it’s going to hurt; it’ll hurt us immensely. It’ll hurt emerging markets. I’m thinking Europe as well. The US has incredibly low unemployment. Their economy seems to be fairly robust. Europe perhaps less so, however – and as you said it already has the war on its eastern side with Ukraine, which has already put pressure on energy.

ISAAH MHLANGA: Absolutely. Europe is coming in this environment with low growth, particularly the likes of Germany, the biggest economy there. And then you have the UK also not in a good space, already with high inflation and still expected to increase interest rates relative to the US because they have structurally higher inflation. So if we have an energy shock coming out of this war it is going to hurt Europe more, because the starting point is already too weak.

For the US the starting point is strong, which means they still have some resilience in the US economy that can withstand, at least for some time, any energy price shocks that we might see.

SIMON BROWN: I take the point which you made earlier, which is that some 10 days or so into the war we don’t know how long this will last, but it’s about being vigilant and about businesses and communities kind of being prepared for what could become a real horror. It might not happen, but rather be ready.

ISAAH MHLANGA: Absolutely. As an assumption, if we just listen to the news flow coming from both sides of the war, it seems as if both countries are doubling down. So there is no end in sight, at least not in the immediate term, and it’s going to be much more protracted. Therein lies the risk. The longer it takes, the greater the likelihood that other countries are going to be drawn into the war and make the risk materialise.

SIMON BROWN: We’ll leave it there.

Isaah Mhlanga, chief economist and head of research at RMB, I always appreciate the insights.

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