South African Rand Looks to March Highs after SARB Eschews Rate Cut

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The Rand shone Thursday after the South African Reserve Bank (SARB) eschewed what would’ve been its fifth rate cut this year despite a darkening economic outlook that forced a downgrade of the bank’s forecasts. 

South Africa’s Rand clocked up gains over all major developed and emerging market currencies after the Monetary Policy Committee voted by split decision to leave the cash rate unchanged at 3.5% in September.

The Rand’s gains were incongruous with the broader performance of emerging market currencies, which were seen mostly on the back foot amid a tentative rebound in some Dollar exchange rates, although some investors and economists had anticipated the fifth cut for this year.

“Inflation expectations have continued to ease this year and “have shifted slightly below the midpoint of the band for 2021.” Accordingly, the Reserve Bank has moderated its average headline CPI inflation forecast,” says Lara Hodes, an economist at Investec. “The Q2.20 GDP outcome was weaker than many had anticipated and although government has endorsed the move to level 1 from 21st September and recent high frequency data indicators point to some improvement in activity, the economic recovery is likely to be protracted.”

Investec had warned that Thursday's decision was a potential impediment to further outperformance by the Rand, which was otherwise seen pushing USD/ZAR down to 16.0 and its lowest since March 10 by month-end. Sterling is seen falling to 21.70 this month before hitting 20.44 by year-end, while Investec tips a USD/ZAR rate of 16.50 by the time the curtain closes on 2020. 

Above: USD/ZAR shown at daily intervals.

Thursday’s decision came despite a darkening outlook that saw the SARB downgrade its forecasts for GDP, with the economy now seen contracting by -8.2% in 2020 when before it was thought to be on course for a -7.3% fall. 

GDP downgrades came after Statistics South Africa said the economy shrank by -17-1% when the second quarter contraction was measured against the same period one year ago, and by -51% on an annualised basis, both being far larger falls than those anticipated by the market or the Reserve Bank. 

“The rand reacted positively, leveraging on the pricing-out of market-implied rate expectations for cuts today, supporting our tactical long ZARRUB position,” says Cristian Maggio, head of emerging market strategy at TD Securities. “While we can't measure implied expectations accurately at this moment, we note that 1x4 FRAs have increased by approximately 10bps since we published our preview on Friday, 11 September (most of which occurred in the two hours following the announcement). This denotes a hawkish market reassessment but leaves the possibility that some 25-30bps of cuts remain priced in the curve.”

Governor Lsetja Kganyago said the SARB’s quarterly projection model, which determines the changes required over the forecast horizon to keep inflation within the 3%-to-6% target band, was no longer recommending any further cuts to the cash rate and instead advocated two hikes in the final quarter of 2021. 

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

This means there could be more upside ahead for the Rand if TD’s Maggio is right about Forward Rate Agreement pricing indicating that some investors in South Africa still expect more rate cuts in the months ahead.

There was little to console South Africans from the SARB on Thursday but bond investors smarting over the reduced yields on offer as a result of the pandemic may have been pleased with Kganyago’s assessment that “inflation is expected to be well contained over the medium-term, remaining below but close to the midpoint in 2021 and 2022.”

The decision came after President Cyril Ramaphosa said Wednesday that it’s time to reopen the country before setting out a plan for South Africa to shift to Alert Level 1, the lowest of a five-tier traffic light style system that will see borders reopened and many restrictions, although a night time curfew remains in place and the sale of alcohol continues to be heavily regulated.

“Whether or not a second wave of infections is forthcoming depends very much on levels of surveillance, vigilance and constant monitoring. SA is not immune, but we are resilient,” says Nema Ramkhelawan-Bhana at Rand Merchant Bank. ”Much will depend on the eradication of graft and the enactment of much-needed and long-awaited reforms that have been agreed to by business, government and labour alike. Policy officials will need to do their part, with the onus falling on the National Treasury to ensure fiscal prudence, which is critical to SA’s sovereign ratings fortunes as our debt burden becomes untenable.”