South African Rand to Outperform Sterling Even as Economy and Rating Outlook Deteriorates

- GBP/ZAR rate at risk amid souring BoE outlook.

- RMB tips GBP/ZAR loss but otherwise soft ZAR. 

- Domestic challenges sideline SA in EM rebound.

- Mboweni vents, Moody's laments lack of reforms.

- SARB to hold rates, sound budget alarm Thursday.

 Image © South African Reserve Bank, reproduced under CC licensing. SARB Governor Lesetja Kganyago.

- GBP/ZAR Spot rate: 18.7541, up by 0.47% today

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The Pound-to-Rand exchange rate is vulnerable to losses if the Bank of England (BoE) interest rate outlook continues to sour, according to Rand Merchant Bank (RMB), even though South Africa's currency is itself tipped for more underperformance as mounting budgetary challenges rankle with investors. 

Sterling is among the worst performing major currencies of the last week, behind only the safe-haven Japanese Yen, as investors move to rapidly price in a Bank of England interest rate cut in the first quarter of 2020.

RMB said Tuesday that if there's one currency the Rand can get the better of this week it will be Pound Sterling, owing to its Bank of England-induced weakness. This is after Monetary Policy Committee member Gertjan Vlieghe said at the weekend that he will vote for an interest rate cut this month if the UK economic outlook does not improve, echoing comments made by the Governor last week. 

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

"USD/ZAR should continue to pivot around the 14.40 mark, having missed the opportunity to capitalise on the strong risk momentum at the start of the week. The only meaningful gains will be evident against the Pound, which continues to falter against the U.S. dollar as markets contemplate a possible BoE rate cut, contingent on the outcome of Brexit negotiations. Yet another episode of déjà vu," says Nema Ramkhelawan-Bhana, an economist at Rand Merchant Bank.

Sterling was unprepared for a rate cut any time soon when outgoing Governor Mark Carney said last week that cuts will follow any further signs of economic weakness. Carney says the BoE can provide 250 basis points of easing in response to a downturn despite Bank Rate being at only 0.75% while colleague Silvana Tenreyro also indicated she's erring toward voting for a cut.

Already two members of the nine-strong MPC voted to cut rates in December so if the Governor and his two colleagues were also to vote that way on January 30 then a reduction of borrowing costs would be all but guaranteed. And once the first cut is in there'd be plenty of scope for markets to price further easing into the bond market for a later date, which would be certain to weigh on Sterling.

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

"In a world defined by geopolitical happenings, idiosyncratic risks are manifesting in changes in government CDS and US dollar bonds spreads. The progressive widening in South Africa’s sovereign risk indicators since the turn of the year (with the 5-year CDS up another 4bp overnight) reflects persistent uncertainty about the macroeconomic and political backdrop as the country continues to bear the brunt of load-shedding, and political wrangling in the upper echelons of government," Ramkhelawan-Bhana.

The Rand has itself been wounded in the last week by its own souring domestic backdrop, leading the currency to sit out the rebound in emerging markets assets that's been prompted by the U.S.-China trade deal and its associated recovery of investor risk appetite. Moody's, the last major agency to still rate South Africa as an investment grade credit prospect, said Monday the country faces years of low growth and with only limited room to reign in its fiscal deficit. 

This is after Finance Minister Tito Mboweni vented his apparent frustration on Twitter last week over unspecified obstacles in government to the reform process. And President Cyril Ramaphosa accepted the resignation of Eskom Chairman Jabu Mabuza after rolling blackouts of varying severity blighted South Africa right through last week in defiance of a pledge to ensure South Africa had uninterrupted electricity between December 17 and January 13. 

Above: USD/ZAR rate shown at daily intervals. Follows 10-year SA gov bond yield, which would rise on a Moody's downgrade.

"Moody’s is now widely expected to strip the sovereign of its only investment grade rating in March. Further potential downgrades from other rating agencies could also weigh on sentiment in 2020. The fiscal and electricity crises signal that government should speed up policy reforms. We forecast GDP growth of 0.8% y/y for 2020, from an estimate of 0.3% y/y in 2019," says Shireen Darmalingham, an economist at Standard Bank. 

Moody's will announce its next rating decision in March just weeks after the February budget update in which markets will be hoping to see a credible plan for eliminating the deficit and stemming an increase in the debt-to-GDP ratio. As a minimum the market is looking to see some kind of improvement on the disastrous situation set out in October, which might be unlikely even without the three-quarter-long recession that some are now tipping for South Africa. 

The commentary from Moody's and RMB comes just days before the latest South African Reserve Bank interest rate decision that's due at 13:00 on Thursday. Consensus is for the SARB to leave its cash rate unchanged at 6.5% so any surprise rate cut would likely hurt the Rand. However, and in addition to guidance on the outlook for interest rates, markets will also be listening closely for any comments about South Africa's budget situation. 

"Unless the government delivers a massive - but unlikely - surprise in the next budget, a downgrade could very well be in store for March, which would put the SARB in the same situation it is in now. Therefore, May is the first reasonable time for the MPC to think of cutting rates," says Cristian Maggio, head of emerging market strategy at TD Securities. "If the SARB holds, USDZAR is likely to move slightly lower 0.2%. If the SARB cuts, we expect ZAR weakness, with USDZAR moving 0.4% higher."

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