"The inflation-targeting South African Reserve Bank (SARB) has communicated its policy reaction function clearly, even amid weaker growth" - Standard Chartered.

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The Pound to South African Rand exchange rate rally has stalled at more than two-year highs in recent days but it could remain elevated near those levels if domestic economic difficulties lead the South African Reserve Bank (SARB) to adopt an "incrementally more dovish" stance on Thursday. 

South Africa's Rand overlooked rising bond yields to advance against a broadly softer U.S. Dollar and a mixed bag of Sterling exchange rates on Tuesday with an outperformance that has helped to cement it into the top spot among G20 currencies for the recent week.

The Rand has weathered volatile international markets for stocks, bonds and commodities while pulling GBP/ZAR lower from some of its strongest levels since August 2020 over the recent week.

"Nothing in particular triggered this ZAR rally, but it should be noted the currency was vastly oversold in previous weeks. In addition to this, the fear of contagion in the banking crisis has calmed down slightly," says Sebastian Steyne, an FX risk and hedging specialist at Sable International. 

"The market is expecting a 25-bps hike, but any diversion will be a volatility-causing event," Steyne says of Thursday's interest rate decision.

Above: Pound to Rand exchange rate shown at daily intervals with selected moving averages and Fibonacci retracements of 2023 rally indicating possible areas of technical support. Click image for closer inspection. 

Rand outperformance comes amid a downward drift in U.S. Dollar rates that was reinforced last Wednesday when Federal Reserve (Fed) Chairman Jerome Powell suggested recent turbulence in the banking sector could do some of the work of interests by helping to bring inflation.

The idea is that reduced lending and lessened availability of credit would dampen the economy enough to constrain price growth, although this would be at the expense of the U.S. Dollar by depriving it of additional or otherwise better-sustained increases in government bond yields.

The Fed's dissipating hawkishness has helped to pull USD/ZAR away from post-pandemic highs while adding weight around the ankles of GBP/ZAR, although higher-than-expected South African inflation and its possible implications for SARB policy may also have been at work in all of this too. 

"Loadshedding has become a significant cost factor in the domestic economy, adding to CPI inflation, and a key reason why the inflation rate came out higher than consensus," says Annabel Bishop, chief economist at Investec.

Above: Investec forecasts for quarterly average exchange rates. To optimise the timing

of international payments you could consider setting a free FX rate alert here.

"SA’s food price inflation, the largest component of the CPI basket, is likely to remain elevated, which along with loadshedding and rand weakness is impeding inflation descent domestically," Bishop writes in a review of South Africa's February inflation figures. 

Statistics South Africa said last week that inflation rose 0.7% in February to lift the annual pace of price growth from 6.9% to 7%, leading many economists to become more confident when anticipating another increase in the cash rate from the South African Reserve Bank this Thursday. 

The consensus is that Thursday will see the cash rate lifted from 7.25% to 7.5%, although there is uncertainty about what this will mean for the Rand and partly because of how load-shedding at Eskom and the resulting electricity shortages are impacting the economy.

"The inflation-targeting South African Reserve Bank (SARB) has communicated its policy reaction function clearly, even amid weaker growth," says Razia Khan, head of research for Africa and Middle East at Standard Chartered. 

Above: GBP/ZAR at weekly intervals with Fibonacci retracements of 2020 downtrend indicating possible areas of technical resistance for Sterling, and selected moving averages denoting prospective medium-term technical support. (If you are looking to protect or boost your international payment budget you could consider securing today's rate for use in the future, or set an order for your ideal rate when it is achieved, more information can be found here.). 

Equipment failures at Eskom have caused unprecedented levels of power outages this year and already led the SARB to downgrade its forecasts for the South African economy back in January but the risk is now that these factors further impact the bank's policy stance on Thursday. 

Economists and markets widely expect an increase in the cash rate on Thursday so the Rand might struggle to benefit much from this sort of outcome while the currency would likely sustain fresh losses if domestic economic difficulties lead the SARB to leave borrowing costs unchanged this month.

Either outcome is potentially enough to ensure GBP/ZAR remains well-supported near to its recent three-year highs in the days ahead.

"We expect an incrementally dovish shift in SARB communication, given the weak economy as well as the less hawkish external backdrop," says Bojosi Morule, a CEEMEA economist at Goldman Sachs.  

"Given our expectation that inflation will fall sharply in the coming months (to levels roughly consistent with the 4.5% target mid-point by mid-year), we believe that the hiking cycle will likely be complete following the March MPC meeting, and we have penciled in rate cuts beginning in early 2024," Morule adds.

Above: GBP/ZAR at monthly intervals with Fibonacci retracements of 2015 downtrend indicating possible medium-term technical resistances for Sterling, and selected moving averages denoting prospective support. Click for closer inspection.