South African Rand Scores another Multi-month High after Reserve Bank Hikes Interest Rate

Johannesburg, South Africa, Image © Adobe Stock

- SARB defends ZAR and inflation outlook with surprise rate hike.

- Oil collapse not enough to tame risks given global environment.

- Land reform, Moody's, still huge risk to ZAR says Standard Bank.

The Rand reached a fresh three-month high Thursday after the South African Reserve Bank (SARB) surprised markets by raising its interest rate for the first time almost three years. 

South African policymakers voted to lift the cash rate by 25 basis points to 6.75% Thursday, reversing a March rate cut and taking the market by surprise, given consensus was for the benchmark borrowing cost to remain at 6.5%.

Most notably, the SARB hiked rates despite acknowledging that the inflation outlook has improved since September and even after cutting some of its consumer price forecasts. 

Changes in interest rates are only normally made in response to movements in inflation but impact currencies because of the push and pull influence they have on capital flows and their allure for speculators. 

"The approach of the MPC is to look through the first-round effects and focus on the possible second-round effects of supply side shocks. However, shocks of a persistent nature such as extended periods of currency depreciation, elevated oil prices and multi-year electricity price increases make it difficult to disentangle these first and second round effects," says Governor Lesetja Kganyago. 

The inflation outlook has turned for worse this year thanks to what was once a near-20% rise in oil prices and Federal Reserve (Fed) interest rate policy.

South Africa is an oil importer so rising prices have a two-fold effect on the country. Not only do they push up inflation and reduce growth, they also see more Rand sold on markets because oil prices are Dollar-denominated. 

Rising returns in the safe-haven U.S. bond market, resulting from Fed policy, have drained capital out of risky emerging markets and driven the Rand to a double-digit depreciation this year. A weaker currency stokes inflation by making imported goods more expensive to buy.

"The MPC had to decide whether to act now or later," Kganyago explains. " Delaying the adjustment could cause inflation expectations to become entrenched at higher levels and thus contribute to second round effects, which would require an even stronger monetary policy response in the future."

Since the last interest rate decision Brent crude oil, the global benchmark, has fallen 20% from $80 per barrel in October to just $64 in November and now trades at a -3.45% loss for the 2018 year.

This neutralised the threat coming from oil prices but it does not address the threat still posed by the currency and bond markets, which are being driven by the Federal Reserve policy or those of other G10 central banks.

"Global financial conditions, financial market volatility and the change in investor sentiment towards emerging markets remain key external risks to the rand. Over the medium term, it is likely that the rand, along with other emerging market currencies, will remain volatile," Kganyago warns. "Monetary policies in some advanced economies will likely be tightening throughout the forecast period."

The governor also says the SARB's internal model is suggesting three more rate hikes of 25 basis points each, taking the cash rate up to 7.5%, are necessary before the end of 2020 but that the bank's actions will be "data dependent". 

Above: USD/ZAR rate shown at daily intervals.

The USD/ZAR rate was quoted -1.27% lower at 13.75 Thursday, a new three-month low, denoting a weaker U.S. Dollar and stronger South African currency. The rate is now up 11.21% for 2018.

The Pound-to-Rand rate was -0.64% lower at 17.70, denoting a stronger Rand that has been partially stymied in its advance by a resurgent Sterling. The rate has now risen 6.29% for 2018.

Above: Pound-to-Rand rate shown at daily intervals.

"The rand remains vulnerable to global risk aversion. Another risk to inflation stems from higher-than-expected electricity tariffs. Eskom has applied for a 15% tariff increase over the next three years," says Mpho Tsebe, an economist at Rand Merchant Bank. 

Tsebe and the Rand Merchant Bank team correctly predicted November's hike on Wednesday, citing an anticipated desire among SARB policymakers to protect the bank's credibility as an inflation-fighting institution and to help shield the Rand from developments in international markets that could have an adverse impact on the emerging world. 

"A number of risks could see the rand trade weaker. For instance, the market remains wary of policy uncertainty in terms of the amendment to s25 of the SA Constitution as well as Moody’s potentially downgrading SA’s sovereign rating to non-investment grade," warns Zaakirah Ismail, a bond market strategist at Standard Bank.

South Africa's parliament formally adopted the Joint Constitutional Review Committee’s (CRC) recommendation to change the country's constitution to enable the expropriation of land without compensation. 

The Expropriation Act was designed to placate the radical Economic Freedom Fighters grouping of the parliament ahead of an election year but critics say Critics say it has negative implications for human and private property rights, while also claiming it could deter investment from South Africa's struggling economy. 

Parliament's push on expropriation, which advocates say will correct racial disaparities in ownership that have roots in the imperial age, comes at a time when South Africa's last remaining local-currency investment-grade credit rating is at risk.

South African Finance Minister Tito Mboweni delivered a spending plan in late October that is estimated to leave the budget deficit at at 4% in 2018 and 4.2% in 2019, before the mismatch between government income and spending stabilises at 4% in subsequent years. That is a significant deterioration from the projections reported back in February.

After having staved off the threat of a credit rating downgrade to "junk" status in February, analysts are once again pondering how much longer Moody's will leave the unchanged for. If the expropriation push looks as if it will slow the rate of economic growth or deter investment from South Africa at any point, then it could push Moody's into action.

A loss of investment grade status would be destructive for the Rand and the economy because it would force institutional investors whose portfolios track the Citi World Government Bond index to jettison South Africa's bonds.

Foreigners were known by authorities to have held around 40% of South African government bonds back in August so any downgrade would be sure to prompt a significant pickup in capital flight from the country and fresh pain for the Rand.

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