Gaza Conflict puts SA economy at risk

The Middle East conflict will have implications for the South African economy and a higher oil price will be the most dire consequence after the price of fuel already escalated substantially over the past two months.

The Bureau for Economic Research (BER) at Stellenbosch University says while the humanitarian consequences on both sides of the conflict are heartbreaking, financial markets were also affected.

“Most notably, after plunging the previous week, the Brent crude oil price surged again last week, with the 1-month oil future ending the week back above $90 per barrel amid concerns that major oil producer, Iran, could be dragged into the conflict.,” Hugo Pienaar, chief economist at the BER, says.

“Oil output in Iran would not only be affected in the event of Israeli strikes on the country, but also due to the possible reimposition and/or tightening of Western sanctions against Iran. The Iranian regime has not only financed Hamas for many years, but the suspicion is also that the county may have helped with the planning of the Hamas attack on Israel that sparked the outbreak of war.”

The uncertainty caused by the conflict also saw a flight to perceived safe-haven assets and this supported the gold price, which gained almost 5% over the week. Pienaar says it is important to note that global bond yields moved lower after a relentless rise in recent months.

In the US, this was not only driven by safe-haven flows, but also commentary from several Fed policy makers that by tightening financial conditions, the sharp rise in bond yields was doing some of the Fed’s work, Pienaar says.

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Higher oil and precious metal prices

He says in terms of domestic markets, the higher oil and precious metal prices supported the resources sector of the JSE last week and resources ended the week more than 8% higher, supporting an almost 2% w-o-w gain for the JSE Alsi.

David Rees, senior emerging markets economist at Schroders, agrees that the primary transmission mechanism of greater tensions in the Middle East for the global economy would be through higher energy prices.

“The price of Brent crude oil climbed over the past week, hitting around $91 at one stage amid rising concerns that disruptions to supply from the region could conceivably push prices much higher in the future. After all, tensions in the region caused global oil prices to climb substantially in the past. The 1970s was the most dramatic example when prices quadrupled as the region descended into war.”

Could this have a stagflationary outcome? Rees says Schroders track the risk from a supply shock in the “higher commodity prices” scenario published in its latest Economic and Strategy Viewpoint. That scenario was largely based on production cuts by the OPEC+ group of fossil fuel exporters, driving Brent up to $120 per barrel which would push the global economy in a stagflationary direction from Schroders’ baseline.

“Higher commodity prices lead to an increase in inflation, while the risk of second round effects, such as rising wages and prices, against a backdrop of tight global labour markets would tip the balance at central banks towards some additional rate hikes.

“Those lingering concerns about ingrained inflation would also delay the eventual pivot to rate cuts until later in 2024, meaning that monetary policy is more restrictive throughout next year. Tighter monetary policy and a squeeze on households from higher commodity prices would result in slower growth, creating a stagflationary outcome,” Rees says.

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Fading effects of high energy prices after Ukraine war

He points out that the fading effects of past increases in energy prices after Russia’s invasion of Ukraine early last year were a key driver of global disinflation over the past year, but that trend had already begun to reverse before the recent tragic events as G7 energy inflation actually climbed from -8% in July to -1% in August.

“Even if oil prices remained at their current level of $91 per barrel, energy inflation would turn positive into next summer before fading away in the second half of 2024. Oil prices need to climb much further to derail the steady decline in headline inflation.”

Rees says tight labour markets, as underlined by the September payroll growth in the US and a fresh historic low in the eurozone’s unemployment rate in August, mean that any sustained increases in inflation could eventually feed through to wage settlements and cause inflation to be stickier for longer.

“With the Fed already opening the debate over a final rate hike in its latest dot-plot, concerns about second-round effects could easily tip the balance towards another hike in November if oil prices climb further.”

However, he says, the immediate threat to broader inflation from higher energy prices should not be overstated. “Indeed, our analysis shows that energy prices account for only 1.7% of core CPI, meaning that the direct impact of higher oil prices on underlying inflation would be minimal.”