South African Rand Slips after Reserve Bank says Fewer Rate Hikes Needed

Image © Government ZA, Reproduced Under CC Licensing

- ZAR slips after SARB says only one hike needed before 2022.

- Improving inflation outlook behind new interest rate guidance.

- After oil price falls 30% in Q4 2018 and ZAR recovers losses.

The Rand has had the wind taken out of its sails after the South African Reserve Bank (SARB) said the inflation outlook has improved significantly since November and there is now less reason for it to raise interest rates again any time soon. 

The bank left its interest rate unchanged at 6.75%, in line with market expectations, and said its financial model now suggests that only one more rate hike will be necessary before the end of 2021 in order to keep inflation in check. 

That is a significant reduction from the three rate rises the model was advocating back in November, which explains the Rand's weakness. 

"Since November 2018, international developments have been the major contributor to an improved inflation outlook. Significant declines in international oil prices and a less depreciated exchange rate have been key drivers of this improved outlook," says Lesetja Kganyago, Governor of the SARB.

Inflation is now likely to average 4.8% in 2019 according to the SARB, down from their December forecast of 5.5%, which had itself been reduced the 5.7% projection issued following the bank's September meeting. 

"The SARB hawks that circled in November 2018 seem to have migrated, making space for gentle doves. It was largely expected that the MPC would keep interest rates on hold at 6.75% and that the governor would remain resolute in his stance on the SARB’s mandate. What was unanticipated, however, was the extent to which the SARB lowered its inflation profile as well as the governor’s dovish tone," says Nema Ramkhelawan-Bhana with RMB in Sandton, Johannesburg.

A 30% fall in the international oil price between September and the end of December has made a significant contribution to this, although an improved outlook for the Rand has also been at play too.

South Africa's currency has enjoyed a boost in recent weeks thanks to a landmark shift in Federal Reserve (Fed) interest rate policy. 

The SARB is required by law to use interest rate policy to ensure inflation remains within the 3%-to-6% range. It only tends to begin raising interest rates when its inflation forecasts suggest consumer price growth will soon challenge the upper end of that target band. 

Policymakers raised South Africa's interest rate from 6.5% to 6.75% back in September to counter mounting inflation risks and defend the Rand. 

"Headline CPI inflation is now expected to peak at around 5.6%, in the first quarter of 2020. Core inflation is expected remain unchanged at 4.3% in 2018 and forecast to average 5.0% in 2019 (down from 5.3%), 5.1% in 2020 (down from 5.5%) and 4.8% in 2021," says Kganyago.

Kganyago says those inflation forecasts assume the bank follows the interest rate path recommended by its quarterly projection model, which is the same model that is now advocating a lesser number of  hikes over the coming years.

"What was unanticipated was the extent to which the SARB lowered its inflation profile as well as the governor’s dovish tone," says Nema Ramkhelawan-Bhana, an economist at Rand Merchant Bank. "With local elections and Moody’s yet to come, and asset prices likely to be more volatile over the medium term, inflation prospects could change dramatically."

Above: USD/ZAR rate shown at daily intervals.

USD/ZAR was quoted 0.58% higher at 13.76 Thursday but has fallen -4.07% so far this year, after a Rand-punishing double-digit increase in 2018. The Pound-to-Rand rate was up 0.81% at 17.72 but has declined -2.65% in 2019.

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

"With the Fed no longer hiking aggressively, China providing stimulus and the rand a lot lower than it was for the previous meeting, the SARB has some breathing room," says Michelle Wohlberg, a bond market strategist at RMB.

Lower inflation and interest rates are good news for South Africans and the economy, which was pushed into a brief technical recession in 2018 by a series of domestic and international factors. Kganyago says that recession means the economy likely grew by just 0.7% last year, down from 1.3% in 2017. 

A slower pace of rate hikes and falling inflation will leave more money in the pockets of South Africans, supporting the economy at a time when the government is under pressure from markets and ratings agencies to reduce its debt burden as a portion of GDP.

"Considering the SARB’s intention to anchor inflation expectations around 4.5% (the mid-point of the target band), we believe that another rate hike is in the offing in the latter part of the year, based on our interpretation of the upside risks to inflation," says Ramkhelawan-Bhana adds.

Such support could also help counter any adverse effects that stem from uncertainty over the outcome of 2019's general election, this year's budget process and lingering fears over the nation's credit rating. 

Moody's, the last main agency to still rate long-term South African debt as investment grade, will review its rating in March. That is less than a month after the next budget, which is due in February. 

Finance Minister Tito Mboweni unveilled a 2019 spending plan in October that puts the deficit at 4% for 2018 and 4.2% in 2019, before the financial void stabilises at 4% in subsequent years. 

That is a significant deterioration from the projections reported back in February, and one that Moody's will want to see pared back if it is to leave South Africa's investment grade status in place.

South Africa's general election, which is expected to be held in the first half of 2019, will mean "populist" rhetoric and political uncertainty increases over the coming months according to Investec Bank. 

Investec says risks to the Rand are tilted to the downside this year because of the election and ongoing threat to South Africa's investment grade credit rating.

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