Good afternoon. Thank you for the opportunity to present at this monetary policy forum with the title 'Anchor in a Storm'. So, I just want to also take the opportunity to say thank you very much to the whole team that's worked on this MPR. I'm very proud of the product that we've put on the table. Let me start then with an outline of the presentation.
Globally, stagflation concerns is resurfacing on the back of the Middle East conflict. The trajectory of central bank policy rates is now less certain and the markets are thinking or pricing in that rates may actually go up. The improving South African macro fundamentals have fostered resilience. And we've also seen that over the past year, economic growth has improved. Inflation is contained, but the near-term outlook is certainly for risk to the upside.
Near-term, the path for the SA policy rate is less clear at this point in time. As I've described, there's lots of uncertainties globally and that may impact inflation and obviously the way that the bank sets policy. Overall, we think that the shock will delay but not derail the achievement of the 3% inflation target.
So let me start off by bringing under your attention how the conflict in the Middle East has raised uncertainty and volatility. As you can see on the left hand side graph we've got two measures there, the geopolitical risk and trade uncertainty. And you can see that trade uncertainty has already risen very sharply last year when Trump started doing all these different trade tariffs. That has raised global trade uncertainty. We've also seen geopolitical uncertainty spiked very significantly after Russia invaded the Ukraine. It has come down but it still remains elevated. As you can see there over the longer term when you compare it to the pre-2022 invasion you can see that these geopolitical risks has remained relatively high.
If you then move on to the right hand side graph, when we look at the volatility index we can see that that's increased sharply. That's the green lines and then the pink line which is the MIRROLABS option volatility estimate which depicts the expected interest rate movements over the next 30 days. We've seen that also increasing very sharply. So all of these measures indicate to us that there's a lot of fear, there's uncertainty and instability in the global economy.
Now the place where you're probably also familiar with where most of this uncertainty is easily seen is what is happening in the oil market. On the left hand side chart we see that Brent crude oil prices have risen by 70% since the onset of the war. And natural gas prices has gone up by 75%. If you look at the futures prices, those for 3 months and 6 months respectively has gone up by 44% and 22%. So a very big impact on the oil market of course with ramifications for the global economy.
If you look on the right hand side graph which depicts urea prices, you can see that as oil prices has gone up and the whole situation in the Middle East has escalated, there's a lot of concern about whether there's going to be enough fertilizer globally and as a result fertilizer prices has also increased very sharply which obviously is going to have implications for food prices going forward.
So just very quickly on this slide and governor I hope I'm not going to contribute to slide inflation but I'm going to go fast through this slide. Overall what we're seeing here is that goods inflation for emerging markets has already started picking up and as you see oil prices and so forth rising, fertilizer prices I've already mentioned, these prices is likely to go up and going to imply higher inflation rates going forward. On the right hand side chart, although that lines look relatively steady, the problem is that for services inflation, they've been above target for a long time and only very slowly coming down. So they've been quite sticky in coming down and likely to remain a concern going forward.
So in terms of global inflation, what you see on this graph here is that in January 2026 the IMF was expecting that global inflation will continue to go downward. If you look at that, I don't know if it's pink or purple going down indicating to you that inflation is likely to continue its downward path. However, in April 2026, you can see that they've now revised it upwards due to all these developments in the Middle East for instance. And they've also done two additional scenarios where you can see under a severe and adverse scenario how much higher global inflation can actually go.
So if we then tune in into advanced economies and the inflation pressures, what is important to look at for here is that the blue dots depicts the inflation forecasts by the IMF in October and then the lighter shaded bars is indicative of the latest April forecast by the IMF. And what you can see is that in many instances that these inflation forecasts have been revised upwards. The only exception maybe there is the Euro zone where we could see that in October, that's the last one over there. We've seen that the IMF were expecting that they will make their inflation target and now due to what is happening they also for the Euro zone inflation is likely to rise above their inflation target.
For the US already in October there were concern or the IMF was at least thinking that they will not make their inflation target, will only reach it by 2028 and given what's happening now that may be postponed even further.
For emerging markets, the story is relatively better to some extent. The revisions as far as the IMF is concerned in terms of their inflation outlook is slightly smaller but nevertheless a concern. I think the bigger issue for emerging markets is that the IMF is also concerned about potential currency depreciations going forward which could impact negatively on inflation rates in these countries. And then also China and many of the Asian economies, they have significant dependence on Middle East energy commodities and given the conflict that may impact them particularly hard.
However, so far currencies are holding up despite the fact that oil prices has gone up and that's helping to mediate the impact of higher energy prices. As you can see here, the exchange rate movements 6 months to date and the year to date. And for most of these emerging market currencies, they've actually gained against the US dollar over the period.
Also, as far as interest rates are concerned, we see that real policy rates remain above neutral in many countries. So what we depict here is the neutral rate by the red dots and then the real policy rate depicted by the yellow bars. And as you can see there in most countries depicted here it's either at the neutral rate or above the neutral rate. Which gives them some space for central banks to wait and see what happens with inflation. It gives them a little bit of policy space but obviously the scope for rapid rate cuts has been reduced going forward.
However, when you look at markets, then they've already started pricing in interest rate hikes although central banks remain cautious and hasn't changed their interest rates at the most recent meetings. We see that analysts are thinking that rates will go up and we also see that in terms of the markets and as you can see here in the case for instance of South Africa, there was an expectation that we would cut by around 50 basis points and that's now swapped around and there's an expectation that the rates may actually rise going forward.
The shock will also test global growth resilience. The IMF now estimates that growth in 2026 will come in at 3.1%. That's down from 3.3% at the time of the January forecast. The interesting thing and which I think we should all try and hang on for hope is that last year as you can see there in terms of the blue line, the blue dotted line when the tariff increases came through the IMF expected global growth to come down quite sharply into 2025. However, when the latest numbers has come out, if you look there at the green solid line, you could see that growth actually did not decline and the global economy has actually shown a lot of resilience during last year. So now this time around the IMF is again expecting growth to come down quite significantly. And let's hope that things is this time as good as last year and the global economy show some more resilience going forward like it did last year.
So in terms of specific countries we see here that advanced economy growth, the changes to the growth outlook has been relatively small. There's been a bigger change as far as emerging market countries is concerned. And in fact their growth has been revised from 4.2% at the time of the January World Economic Outlook to just 3.9% in April. Now and then at the far right of this graph you can see South Africa where we expect where the South African economy expanded by 1.1% in 2025.
If we then go into a bit more detail on South Africa, we see that as I've just mentioned, domestic activity increased by 1.1% in 2025. Now that's nearly or more than double the 0.5% we had in 2024. So there is some upward momentum in our growth performance. If you look at the right hand side chart, we illustrate there that this growth was 0.3% in the third quarter which accelerated to 0.4% in the fourth quarter and largely led by household spending and general government. Unfortunately, investment has remained relatively weak and obviously there's also some downside risk to this growth forecast. The conflict could go last longer. There's a worsening due to economic fragmentation risks and then of course the trade tensions could once again also bring pressure for our growth outlook.
Over the past two quarters we've seen that household consumption has increased by 1.2% in the fourth quarter of last year. So household consumption growth was very strong but it's also at least over the last two quarters we've seen that all the subcategories within household consumption have shown a relatively strong growth.
So what is the major reasons behind the strong consumption expenditure? We think there are maybe four major reasons. The first one is depicted there on the left hand side graph where you can see that historically we see that when inflation is high consumption growth is low and vice versa. So with inflation coming down quite significantly that's underpinned also the stronger household consumption growth. Then which I don't depict here on the graph but also two-pot withdrawals has supported economic activity or spending by households. Then on the right hand side graph another reason was the increase in real credit extension. Household credit extension increased by 12.2% in February year on year in real terms. And also mortgages and unsecured lending has contributed positively. And then finally another big reason for household consumption expenditure being very strong is what is happening in terms of wealth effects.
And on the next slide we just depict what has happened to the Johannesburg Stock Exchange which has increased by some 40% since the start of 2025. Now that's related to on the one hand higher commodity prices but it also to some extent reflect improving macro fundamentals such as lower interest rates.
And as we talk about the terms of trade, obviously this sharp increase in the terms of trade has also been reflected in the current account which has recorded a surplus of 0.6% of GDP in the fourth quarter. As you can see there on the left hand side graph, there's a very strong correlation between the terms of trade and the current account balance. In fact, if you look at that since 2010, that correlation is almost 90%. So current account changes largely driven by terms of trade improvements.
The flip side of the current account surplus also relates unfortunately to the fact that our investment has remained relatively weak. We've seen very weak growth in investment for quite a period of time and given its high import content we've not seen a lot of imports and what we've seen on the right hand side graph is that the import penetration ratio has come down over the period and that's in line with what has happened to the investment ratio when depicted as a ratio of GDP which has also come down. So one of the major reasons there.
So over the medium-term we expect growth to come closer to 2% largely driven by consumption. As I've mentioned unfortunately investment is relatively weak. If I can do an infomercial quickly, I'd like you to when you go back home, look at box five in the MPR. We have a box on potential growth. And what we've seen is that our potential growth has largely been driven by on the account of labor inputs and a very small contribution by capital. Whereas TFP growth has been negative over the period and hence that's what I've been pleading for is that investment should rise as if we want to increase the overall sustainable GDP growth rate in this country.
Then just quickly in terms of portfolio flows, we've seen that the increased global volatility has also impacted on the portfolio flows into South Africa. I think last year we've seen globally a risk on environment. So capital flows to more risky assets around the globe and especially emerging markets increased as depicted here by the blue line for total emerging market inflows. We've seen the same thing in South Africa. In fact, for us, it was probably stronger because not only was risk on there, but South Africa introduced a new lower inflation target that improved the macroeconomic fundamentals. We've seen renewed efforts in stabilizing the fiscal, to do more fiscal consolidation and all of those things contributed to improved situation and attracting foreign capital inflows.
Now obviously since the start of the conflict that is reversed and you can see there at the end of the period we see those portfolio flows both for emerging markets and South Africa turning down. We can just hope that the conflict and the war is hopefully coming to an end and that this is just a blip and that the upward trajectory continues.
So what we've also seen is South African bonds as I've already mentioned due to fiscal consolidation and the lower inflation target we've seen the yield curve shifting downwards. So from the yellow line down to the pink line. But it's not only shifted down it's also become more flat. And despite the fact that we've recently seen some turmoil in global markets in terms of the uncertainties that I've highlighted it has shifted upwards again but as you can see the latest yield curve depicted by the green line there is just a little bit higher than the pink line and still signify a significant improvement from the situation as depicted by the yellow line about a year ago.
Then we've also seen that the rand has benefited from better macro. I've already touched on that. But what you can see here is that the rand has strengthened quite significantly and it's now back to levels that it was about 3 years ago. In fact, the rand traded at below 16 rand to the dollar in January this year, which was about a 13% gain during the course of the year.
So with the rand being stronger over the review period, we've had a favorable impact on headline inflation. It has come in at the target and as you can see there depicted inflation has been hovering around the 3% for quite a while in fact since October 2024 and that's largely due to the impact of fuel inflation over the review period obviously that's reversed now but for a large part of the review period fuel inflation was coming down and we've also seen very modest rises in core inflation.
So talking about core inflation, one of the key drivers of core inflation is obviously what happens to inflation expectations. We've seen that inflation expectations as measured by the Bureau for Economic Research came in at 3.6% in the first quarter of this year which is a historical low. And then another infomercial, box two in the MPR talks about firms becoming more attentive. So they pay attention to what is happening to macroeconomic conditions and we think that's also helped to bring down inflation expectations. In fact if you look there at the right hand side chart they've done a survey and they ask firms whether what is the inflation target of the reserve bank and nearly 50% of them knew that it's been reduced to 3% and then another big chunk of the firms surveyed indicated a value below 4.5%. Unfortunately they didn't get the 3% right but at least they knew that it's below 4.5%.
So going forward, the tailwinds that I've described, so we've said that over the past year the strong low oil prices, low fuel prices has helped to bring down inflation that's of course now going to change going forward due to the situation in the Middle East and we forecast that fuel inflation is likely to rise quite significantly over the next year or so. Obviously depending on how long this conflict is going to be and to what extent oil prices remain elevated.
What we also depict here is the impact of the fuel levy, the three rand per liter reduction. Obviously that was not part of our baseline forecast in March. This reduction came through after the forecast was done for the MPC but we've done a simulation and the green line there depicts what the impact would have been if we had known at that time already that the fuel levy will drop by three rand and you can see it makes some difference in the initial months of this year. It would have been lower if the... sorry the green line is the March forecast. The pink one is the one where we take account of the three rand reduction in the fuel levy and you can see it being lower there in the initial months but then after a year you get some base effects and the opposite happens into next year.
Then part of the whole fuel levy story is obviously also what is happening to margins. Refinery margins has increased very significantly especially for diesel. Those of you that's driving diesel cars will know it's been pain. And we've seen the diesel refinery margin increasing very significantly. We think that over the near term it's likely to stay that way. So obviously the fact that at the pump prices last year came down so significantly was due to lower fuel prices but given what's happening to oil and refinery margins this is now going to reverse going forward.
And I've already also mentioned that the food forecast is likely to be impacted by the Middle East. That's due to the fact that to plant and to harvest you need a lot of fuel. So that's going to raise the cost of production of food. But then also for fertilizers is going to become much more expensive. And given those pressures, we're likely to see food inflation rising going forward. And you can see there in the chart we show how the food inflation has been raised going forward. There's also other pressures on food inflation going forward. Apart from the fertilizer and diesel there's also the foot and mouth disease which is hopefully coming to an end but maybe there's still some pressures there. And then I've the other day read in the newspapers there's a lot of concern that we may be in for another super El Nino this year. So hopefully they're wrong. But certainly there's a risk that El Nino could come through.
So given these things, we've done a simulation to look at what's the impact of a 10% increase in oil prices. And what we can see here is on the left hand side chart that a 10% rise in oil prices raise headline inflation by about 0.3%, food prices by 0.2% and inflation expectations by 0.1%. And then on the right hand side chart what we depict there is the evolution of our unit labor cost forecast. And you can see that since September 2025 in every meeting the unit labor cost forecast has been raised and it comes out about 5.2% for by the end of this year. Now that reflects some second round impacts coming through and as a consequence we see unit labor cost being revised higher.
Then we've done for the March MPC given all these uncertainties we've seen globally, we've done two different scenarios to see what the impact will be of the shocks in the Middle East. And we've done two scenarios, an intermediate and a severe scenario. So in the intermediate scenario we assume that the conflict in the Middle East lasts for about two months. The Strait of Hormuz is then reopened. Oil flows resume again. In that case we saw oil prices rise on average for the year this year by about $7. And then next year it's about $4 higher than in the baseline and then only about $2 higher in 2028. And we also assumed that the risk premium rises by 10% while the rand depreciates by 5% at its peak.
In the severe scenario, we have looked at the conflict lasting more than a year. There's significant damages to the infrastructure. There's a prolonged blockage of the Strait of Hormuz. And in that case, we see like a $19 on average increase in the oil price this year. Another $50 compared to the baseline next year. And then even in 2028, oil prices are still $38 higher than they were in the baseline. On top of that, the risk premium rises by 20% and the rand depreciates by about 10% at its peak.
So as you can see here is the impacts depicted. You can see that in this severe scenario we see headline inflation could rise by at its peak at about 2% more than it is in the baseline. And sorry that's for food inflation and core inflation then also start rising as depicted here by the yellow line being about 1% higher than in the baseline.
And obviously due to the fact that inflation is so much higher, policy response we see that in the baseline sorry in the intermediate scenario there's not much of a change in terms of the policy rate maybe about a quarter of a percent higher but then when we look at on average for 2026-27 but then when we look at the severe scenario interest rates are 1% higher in the first year and about 1.5% on average higher in the second year. So quite a negative impact as far as interest rates are concerned.
The important thing that I think we want to emphasize is that despite this shock under the severe scenario we see inflation returning back to the target. It takes some time but by the year 2028 we see headline inflation back to the inflation target.
So that's my story. To conclude, we see that the Middle East war has raised stagflation concerns. The impacts are still uncertain as the conflict is evolving. The question is how will central banks respond? And markets appear to have taken a view that they will have to hike. For South Africa, the question is to what extent will our growth be impacted given what is happening globally. Also with regard to inflation, inflation is currently at target but obviously given what is happening to oil prices there's upside risk to that inflation. But also we see in this shock that inflation will return to the target but obviously to do that interest rates may have to rise. Going forward there's new risks. I've already mentioned El Nino. We don't know how this conflict will end. Hopefully it's going to come to an end, but if not, it could bring some more pain and obviously policy makers need to remain vigilant and act prudently. Thank you.
