Fuel drives SA inflation to 4.5%, but core pressure stays contained

Inflation in South Africa is rising, though more slowly and more narrowly than initially feared.

Headline CPI rose to 4.5% year-on-year (y-o-y) in September from 4.4% in August, below consensus. The increase came almost entirely from fuel. Core inflation, a better gauge of underlying pressure, eased for a second month to 4.0%, which shows the oil shock has not spread into wages, rentals or services.

Households are still under pressure however: essential costs are climbing faster than incomes, and a more benign food inflation environment, the main offset so far, will fade as El Niño takes hold.

For the South African Reserve Bank (SARB), the data suggests September's hike was enough and a hold in the next November MPC meeting is the more likely outcome. For investors, the outlook rests on the oil price and the rand, with clear consequences for rates, the currency, equity sectors and the role of alternative strategies.

The current rise in headline inflation is almost entirely about oil. Fuel inflation reached 27.9% y-o-y in September, and diesel is 46% more expensive than a year ago. Because diesel powers freight, farming and mining, its cost eventually feeds into the price of almost everything that is moved or grown.

August's calmer reading came from a brief dip in fuel prices that has since reversed. Under-recoveries of R2.70–R3.00/litre after the September adjustment pointed to another increase in October. The impact on household budgets is already visible in transport costs, which are 12% higher than before the Iran war.

Airfares are up 22%, but taxi fares, up 13%, carry more weight for households. Minibus taxis are the daily mode of transport for millions of commuters, so lower-income households are bearing the brunt of the fuel shock.

A more benign food inflation environment has absorbed much of the fuel shock. Food inflation was only 1.2% y-o-y in September, and the SARB notes it is near its lowest level since 2010, thanks to strong harvests and steadier meat prices. That relief is most significant to lower-income households, who spend a large share of their income on food.

It is also unlikely to last. August's data showed fruit, meat and seafood prices starting to rise again, offset for now by cheaper vegetables and cereals. We expect food inflation to rise gradually into year-end, then more sharply in 2027 as El Niño hits harvests. When it does, households will lose their main offset to higher fuel prices.

The most encouraging feature of the data is the absence of second-round effects. Higher fuel prices have not yet passed through to broader pricing, as falling core inflation and weak rental inflation in September show. Rental inflation is widely regarded as a gauge of demand-pull inflation, and its weakness suggests households have limited capacity to absorb higher prices. Wages and services inflation are not responding to the energy shock, which is the outcome the SARB is looking for.

We have revised our CPI forecasts to reflect the September data and the fuel levy relief announced in last week's MTBPS (medium-term budget speech). The relief softens the expected near-term spike in inflation and eases some of the pressure on household finances. Headline inflation will still rise noticeably, and for many consumers it may match or slightly exceed income growth. Inflation in essential goods and services is the greater concern. We expect it to rise to well above both headline inflation and income growth, which means real pressure on household budgets.

Over the medium term, the oil price will weigh far more heavily than the levy relief. Positive base effects should emerge from 2Q27, a year after the initial oil price spike. Even so, our forecast that inflation returns to the new 3% target by 2H27 also depends on oil prices declining.

The SARB has likely done enough

The Monetary Policy Committee (MPC) raised the repo rate by 25bps to 7.25% on 23 September. The decision was unanimous, which was more hawkish than we had expected. The SARB projects that headline inflation will peak at 5.7% in November. The policy rate already exceeds the path implied by the SARB's Quarterly Projection Model, and on our forecasts, no further hikes should be needed. As such, markets largely viewed the hike in September as a pre-emptive move on the part of the SARB. The September undershoot, particularly the soft rental reading, makes a hold at the 19 November MPC meeting the more likely outcome.

Market implications:

– Short-term rates: Two consecutive soft inflation prints, together with lower core inflation, make it harder to justify pricing in further hikes. If the SARB holds in November, as we expect, the front end of the curve has scope to rally. Some caution is warranted. The SARB has made clear its commitment to returning inflation to 3%, and longer-run inflation expectations remain around 4%. Meaningful pricing of rate cuts is therefore likely to wait until base effects turn in 2027.

– The bond curve: Longer-dated bonds face a different set of risks: the oil price, the rand and the fiscal cost of the fuel levy relief. A rally led by the front end, with longer yields lagging, is more likely than a uniform move lower, which would steepen the curve. Shifting heavily into the short end would give up significant convexity, a meaningful cost given the shape of the curve beyond 2037. Retaining longer-dated exposure preserves that convexity, while selective hedging can manage the risks specific to the long end.

– Inflation-linked bonds: Inflation-linked bonds look well placed over the next two quarters. Headline CPI should peak around the turn of the year, and monthly fuel price adjustments will keep inflation accruals elevated. This advantage fades from 2Q27, as base effects pull headline inflation lower, so the timing of a rotation back into nominal bonds will be important.

– The Rand: The currency is the largest swing factor. Higher fuel import costs have pulled South Africa's terms of trade lower, which could weigh on the rand. So far the currency has been resilient, helping to contain import prices. A sustained depreciation would push up import prices quickly and give the SARB reason to stay hawkish despite weak domestic demand. Conversely, rand strength would firm up our view that no further hikes are needed.

– Consumer-facing equities: Essential goods and services are taking up a growing share of household budgets. This is a headwind for discretionary retailers selling clothing, furniture and durable goods. Value-oriented grocers and staples producers should prove more resilient as consumers trade down. The fuel levy relief offers some support at the margin, but it will not offset the expected rise in food inflation.

– Banks and insurers: Higher interest rates support banks' net interest income. Credit quality is the offsetting risk; financially stretched consumers and rising essential costs point to higher impairments, particularly in unsecured lending. Insurers with large float balances benefit from higher yields. Claims inflation in motor portfolios deserves close attention, given the rise in transport-related costs.

– Alternative investments: The current environment makes a strong case for alternative strategies, including hedge funds. Supply-driven inflation shocks tend to push bonds and equities in the same direction, weakening the diversification balanced portfolios rely on just when investors need it most. These conditions are also creating wide dispersion: between the front and long ends of the curve, rand hedges and SA Inc, and defensive and discretionary consumer stocks. Hedge funds can exploit that through long and short positions, relative-value curve trades and active currency management, producing returns less tied to market direction. With the outlook resting on variables as uncertain as the oil price, the rand and El Niño, well-managed alternatives can help protect capital and deliver steadier returns across a range of outcomes.

Ultimately, the oil price, the rand and El Niño will determine whether this hiking cycle stays shallow. For now, the domestic data supports our view. If November's inflation print comes in below the SARB's projected peak, the case for keeping rates unchanged becomes compelling. Photo: Casey Sprake