South African Rand Weakness Allows Pound to Attack 19.00 Level

The South African rand exchange rate complex (ZAR) has been hit hard by the generalised emerging market sell-off and the overall trend is towards weakness in an event filled week.

The UK pound is one currency that is well placed to take advantage of ZAR weakness with momentum indicators advocating for further climbs towards its best exchange rate of 2015.

"The rand is being smacked around by global market volatility but it’s also suffering for its own reasons. Since we do not really understand what these reasons are, it is pretty difficult to tell if they will continue and all we can do is repeat that volatility will remain elevated into Monday. Today represents the eye of the storm in terms of elevated event risks, but we doubt the empty calendar will stop the markets from swinging," notes analyst John Cairns at FNB in Johannesburg..

The grind higher in the pound to rand exchange rate (GBPZAR) has seen a convincing break of the 18.300 hurdle. As the below graphic shows this level is synonymous with the exit point that traders tend to abandon any rallies in the pair:

Now that 18.300 has been cleared and held we sense that rallies could well run back towards the 2015 best that took in GBPZAR 19.0. Could 20.00 be achieved?

"Early illiquid trade out of Asia has seen rand selling resume, with USD/ZAR testing Tuesday’s high of 12.36/37. A breach of this level could accelerate rand selling. Rand losses are much more evident on the crosses: EUR/ZAR has pushed through May’s peak to a five-month high of 13.90, reflecting the combination of rand losses and euro gains," says Cairns.

Note that these rates refer to the wholesale markets and when you make an international payment / transfer your bank will charge a spread at their discretion.

However, using an independent currency provider will get you closer to the real market rate as they apply a smaller spread, in some instances this results in up to 5% more FX being delivered, find out more.

Emerging Market Currencies Struggle

As mentioned, the South African Rand appears to be caught in the general malaise impacting emerging market currencies.

These currencies remain vulnerable to an overall stronger dollar and many in the market will avoid chasing them higher.

Unlike the rest of the world Asia is responding to the softness in domestic growth/inflation with a lag, so we expect this region to underperform. This trend could well catch the ZAR in its crossfire, particularly as Asia is a significant market for South African product.

There are of course the domestic issues to take into account when considering the GBP to ZAR outlook. South African industry remains held back domestic electricity, holding exports back and preventing the expected improvement in the trade gap.

The Key Risk to a Higher GBP-ZAR

South African inflation could well head higher on domestic drivers. Add to this an expected global reflation cycle, and we see prices could well bother the South African Reserve Bank (SARB). The answer will be to raise interest rates.

Higher interest rates tend to inflate the currency; this is expected to be the single most important source of support for the rand for the remainder of the year.

The South African Reserve Bank’s Monetary Policy Committee decided in May to keep the repurchase rate unchanged at 5.75%, many analysts are suggesting an interest rate rise could transpire within months.

That said, Bank of America analysts tell us they are forecasting an interest rate rise to only take place in November. If they are correct we could well see GBP-ZAR given the space within which to advance towards 20.0.