Hopes for a quick end to the Middle East crisis have faded. The Strait of Hormuz is still largely closed. Oil prices have fluctuated around $100 per barrel. In this context, global growth forecasts have been marked down, while inflation forecasts have been revised higher. Some countries have been grappling with energy shortages, especially South Asian economies that depend on Gulf producers. Elsewhere, supplies are intact, supported by large pre-existing inventories, but prices are still up sharply. Households are being squeezed, with consumer prices in the United States, for example, rising 3.8% in April, and inflation in the Euro area at 3%. Bond yields have also risen, especially in advanced economies, which are now borrowing at rates last seen in the 2000s. Given the uncertainty, central banks are still mostly on hold. Markets now project major central banks will increase rates this year, having dropped expectations of cuts.
Moving to South Africa, we have lowered our growth forecasts for the next 2 years. Before this shock hit, the economy seemed to be gaining momentum, with the incoming data mostly positive. Now, however, we face a painful combination of higher global uncertainty and reduced disposable income. This will hit both investment and household consumption, which have been our main growth drivers. The recent floods in the Western Cape, Eastern Cape, and Northwest provinces have also done severe localized damage. The frequency of these extreme weather events underscores the threat from climate change. We see downside risks to growth. That said, the fundamentals of South Africa's economic recovery remain intact, as reflected in the recent decision by Moody's to assign a positive outlook to the sovereign credit rating. The macro economy is demonstrating resilience to global challenges. South Africa's terms of trade remain elevated, lifted by favorable prices for key exports. Domestic reforms continue to support a pickup in growth potential.
Moving to inflation, consumer prices rose 4% in April, up from 3.1% previously. This was mostly due to higher energy costs. After falling by 8.7% in March, fuel prices increased by 11.4%. That is one of the largest jumps in fuel inflation on record. Services inflation also accelerated to 4.6%, well above our 3% target. This partly reflected transport costs, but it also showed non-fuel pressures in areas such as insurance and financial services. At the same time, the exchange rate remains stronger than it was last year. This has to help to contain import prices. Food inflation has also been easing.
Looking forward, we have raised our oil price assumptions. In addition, we see renewed pressure on food prices with the agricultural sector facing higher costs for both diesel and fertilizer. Our forecast now has headline inflation averaging 4.4% this year and 3.7% next year before returning to the 3% target in 2028. Core inflation is also higher, peaking early next year. These projections entail some second-round effects as the shock broadens out into wages and inflation expectations. At this early stage, we don't have clear confirmation of these effects in the data. New results from our main survey of inflation expectations will only be available next month. However, in market indicators and analyst expectations are edging higher. Given the forecast, we see upside risks to inflation.
Against this backdrop, the committee decided to increase the policy rate by 25 basis points to 7% effective from the 29th of May. Four members preferred this action while two favored no change. The committee agreed that inflation risks had intensified and that the challenge of large and overlapping shocks will likely trigger second-round effects requiring a monetary policy response. Our decision was aimed at managing risks and ensuring that inflation returns to target.
The forecast from our quarterly projection model shows one hike this quarter. As inflation falls later in the forecast, our model then has rates increasing again towards neutral levels. Real rates are lower this year given higher inflation, so the policy stance is now less restrictive than it was in March. As before, this rate path remains a broad policy guide. Our decisions will continue to be taken on a meeting-by-meeting basis with careful attention to the outlook, data outcomes, and the balance of risks to the forecast.
Given elevated uncertainty, we continue to find value in scenarios. For this meeting, we explored three risks. One is a prolonged Middle East crisis leading to higher food and oil prices plus a weaker rand. The second included El Niño, a weather pattern that seems to be forming currently and which typically brings drought to parts of South Africa. The third scenario added non-linear effects. Basically, the risk that big shocks have proportionally larger effects on inflation with more costs passed on to consumers. All these scenarios imply higher inflation and lower growth.
For the quarterly projection model, policy must achieve a balance supporting economic activity while guiding inflation back to target over time. To this end, the various scenarios all show some additional monetary policy tightening. The scenario with a longer Strait closure has inflation at about 5% with two more hikes than the baseline. While El Niño rates stay higher for longer. With El Niño effects added, rates stay higher for longer. The most adverse scenario puts all the risks together causing inflation to peak above 6% requiring three extra hikes. These scenarios underscore the importance of food alongside fuel in transmitting the ongoing geopolitical shock. They also show the additional risks from a severe El Niño.
We have already had one global inflation surge this decade and we may well be starting another. In such adverse conditions it is crucial that central banks maintain their credibility and prevent higher inflation from becoming entrenched. Although we do not have the tools to prevent the initial effects of supply shocks, monetary policy is responsible for longer-run inflation. We take this duty seriously and we reiterate our commitment to bringing inflation back to 3% over time. That concludes our statement. And as usual, I will invite members of the media to pose any questions that you might have. And again, do identify yourself and the media house that you represent.
Greetings Governor and deputy governors and everyone else in the room. My name is Fundiswa Baragosa from Reuters. My first question is could we just get a reason for the MPC members that preferred no change to the policy rate? And then my second is, is the SARB's decision today primarily preemptive to anchor inflation expectations or response to realized inflation pressures? That's all. Thank you.
Afternoon everybody. Kopano Gumbi from Reuters as well. A few questions. Firstly, would you say that food price pressures are lagging relative to the immediate fuel shocks that we've seen? Or is there a resilience given the position that the industry was in before the war began? And then recognizing that I'm asking you to be certain about the uncertain, based on what you know now, what does the outlook tell us about the timing and the nature of the second-round effects. Specifically, when do you anticipate that they could start to materialize? Are we looking in the next quarter or sooner? And beyond fuel and food, which other second-round effects are you watching most closely? And how sustained do price pressures in those areas need to be before they become a more serious concern for the committee? I'll ask more in the next round.
Good afternoon, Governor, and the rest of the panel. My name is Ntando Twala from Bloomberg News. My question today is that I'd just like to ask whether a 50 basis points hike was considered in this meeting. And given the assumptions that you've just given us with 7.83%, that's the policy rate as you see it in the most adverse scenario by the third quarter. Could we see an outsized hike larger than 25 basis points by then if the war persists. Thanks very much.
Okay, thank you very much for that. Yeah, in the front. Did you say your name is Sfundo? Sfundo. Sfundo. The statement that you have has got all the views of the committee. And as we talk about the need to balance supporting economic activity and getting inflation back to target, that tells you that the conversations in the committee were more about timing rather than the direction. The direction of travel is very clear that monetary policy would have to react to the challenges that we are facing. And so you ask the question, are you being preemptive? The arrival of second-round effects does not make an announcement. You start to look at signals and see what else you are seeing. So one way of looking at it is to take the inflation as we have it and remove the shock, basically the fuel prices, remove them and see what remains behind. What we have now is that we had removed not just fuel, but we removed fuel, electricity, and food because then that is a measure that everybody is familiar with, which is called core inflation. Even after removing those we are seeing that prices are beginning to rise. And that is what then begins to concern us because it says to us that second-round effects are beginning to show up. So when the second-round effects arrive, it's a question of judgment and time. Do you think they are coming or do you think they are here or do you want to wait to make sure that they are really here before you react? If you are going to wait until they are really here, it's too late. It's outside of your monetary policy horizon. And so, we say in our forecast that we expect core inflation to peak in the early part of 2027. There is nothing that we can do with that horrible April inflation print. Nothing we can do. There's nothing we can do about the May inflation print that is still coming. Where our tools become useful is looking forward. And so, when we are here now, according to our quarterly projection model, policy is more effective three quarters ahead. And given that the peak is in the first quarter of next year, at least with core, which is where we expect core to peak, policy is reacting with that in mind, looking forward rather than earlier. We do state that there is evidence of some second-round effects starting to show up as we have shown. But there could still be more that is coming, and that is why you also realize that we have taken our inflation forecast forward.
And then, which then brings us to Kopano's question about the timing and nature of second-round effects, which I've sort of like dealt with, and she asks, 'Beyond food and fuel, are there other second-round effects?' No, fuel is in the first round. It's a first-round effect. It gets felt immediately. And the food is not so much that we have had a food shock, but we expect that should be coming because of the following. Firstly, we are lucky that our planting season for the summer crops was already done before the shock was done. The winter crops would feel it, but agriculturists tell us that they are not as demanding on fertilizer as the summer crops are. And so, if there is indeed a food shock, that's why we modeled the El Niño. If there is that shock, that will be an additional shock in another way. Now, there are the direct effects from this shock that are coming directly via fuel prices. So, think of it this way. A farmer must operate a tractor and a harvester. They use diesel. So, the price of diesel has gone up. That means the cost of harvesting or the cost of planting has gone up. Then, the crop, if it is maize because that is what most people watch in the country, the maize must go to the silos. So, it must be transported to the silos, but the cost of transporting it to the silos is now higher. And then, the maize must then eventually move from the silos to the mills. That is an additional transport from the silos to the mills. And once it had gotten to the mills and you now have milliemeal, the milliemeal must be taken from the mills to the supermarkets or to the shops, to the retailers, where you buy. So, you can see that there were the immediate direct effects that affected the price of fuel, but because this is an input in that production process, the indirect effects will then start to feed in. And that distinction then about those indirect effects as to whether they are first round or second round is a very thin line, but we would say, 'Well, they are indirect, but where do they lead to?' You will then begin to see that the prices in the supermarkets, in the retailers, go up, and then you say, 'Yes, we can see that the second-round effects have kicked in.' But then you might have to exercise judgment in the process to say, 'I am already seeing this evidence that the input costs are going up, and by when will they be felt?' And you have to take some view. It might be in two quarters or three quarters ahead, and that is what policy would have to react to.
And you asked, I sort of like dealt with your thing about food prices, whether the pressure is lagging. There are two things that would lag it. It is the fertilizer, and of course the cost of diesel going forward. The resilience that you had referred to would have to do with the fact that we had the Crop Estimates Committee, so that we will have a significant crop this year, and so the fact that you have the supply might be cushioning you, but these prices are also set internationally, and it's going to be a question of when we see that coming through. And although, what's 50 basis points considered? Yes. There was a protracted discussion on that. And in the final analysis the view of the committee was that we are still looking for more information and if we are to act cautiously we would do a 25 basis points adjustment to the policy rate and then see what we are getting in data. One of the key points of course had to do with inflation expectations. Because that is the key driver of what future inflation is going to be and the survey from the BER is only coming next month. And so we had to rely with the information that we have and the two that guides us then in the absence of that survey was what the analysts are saying. So we would use consensus from the other house that you are not from. And then we would also impute inflation expectations from the inflation-linked bonds. The difference between the yield on the nominal bonds and inflation-linked bonds and that gives us an indication of where the expectations are going and that is what we would react to. Adverse scenario with the adverse scenario leads to an outsized adjustment in the repo rate. Remember it is not a forecast. It is just a scenario. When that scenario comes, if it materializes, we would look at it and we would have to respond based on the data at that time. So, these scenarios are not forecasts that you would have to try and depend on to see where policy is going. It just tells you if the scenario sets in, this is what we would be faced with. And even the rate path that is in those scenarios like the straight path in the baseline is just a guide that would change depending on data, the outlook on a meeting-by-meeting basis.
Thank you very much Governor. Alister Bull from Bloomberg. You mentioned the rand and I wondered if you've been surprised by the performance of the rand and the resilience of South African assets. 10-year government treasuries are higher in yield but they're lower in yield than they were a year ago. So, what do you think's going on there? Do you think that investors might be giving South Africa a bit more respect?
Afternoon, Bonolo from Bloomberg. I just wanted to get a better understanding of the overlapping shocks that the committee sees would trigger sort of the second-round effects. Thank you.
Repeat that question. Okay. We have got a new member of the MPC. And like all newborns, he seems to announce his arrival. So I am going to give him Bonolo's question to answer and while he figures out Bonolo's question to answer. Alister, performance of the rand. Are we surprised? It depends. And in our statement we do refer to the fact that the South African macroeconomy is resilient. The fundamentals are standing us in good stead. But there are both push and pull factors that have underpinned the performance of the currency. You would remember that at the time the war kicked off, what we had was that we had this massive depreciation in the currency but it came back very quickly. And so in this market now it's yes, there would be a general reaction but then there are also differentiations that must take place. This shock found us better prepared than 2022. But from the domestic side. Firstly, after years the National Treasury used to say the fiscal position will be better in the next 2 years or in the next 3 years. At the time the budget policy statement was presented, they said the fiscal position is better now. And we expect it to get even better. So, the fiscal settings were sound. Secondly, this shock, when it hits you and the manner in which it evolves, the initial conditions matter and I can say from an inflation front, unlike the previous shock of 2022, where when the shock hit us, we were above target. This time around, we were bang on target and we had a lower inflation target that had just been adopted and we were on that lower target. Third is that at the time of the shock, the prices of our exports had risen faster than the prices of our imports. And so, we had a rise in terms of trade. Since we talk about shocks, this was a positive shock. So, we had a positive shock from the terms of trade. They have since adjusted as the oil price went up, but they are still higher than the medium-term or long-term average. That was an important effect to take account. But globally, you also had a situation where the investors were looking for a diversification game. Not, I wouldn't say up from the edge exposure to the dollar, and they were looking for other currencies. And many emerging market currencies benefited from that. So, at times we look at this and we say that, 'Oh, but we are so special. Look at us.' But the truth was that when you looked at other emerging markets currencies, they also appreciated. We had since given up some of the gains, but the currency is still stronger than the average of last year. Fifthly, South Africans have got significant investments outside. That puts us in what is called a net international investment position. We have got more investments outside than foreigners are having investments inside. That cushions the sort of and you will see the thing feeding through. So, there are a number of those global factors that are push factors and there were the domestic factors with sound fundamentals that were pull factors, but importantly was that our structural reform program is starting to show progress and we are starting to see the results. Yes, it might not be as fast as we would like to see it, but it is on track. The chaps in Business Leadership South Africa must be tired of me by now because I keep on referring everybody. Go and look at the BLSA Tracker and then you can gauge for yourself and you can see what progress is actually being made in the various important areas of structural reform. Constantine, that should have given you enough time to gather your thoughts.
