Pound to Rand Exchange Rate Hits 20.02 as Commodity-Linked Currencies Feel the Heat

The rand exchange rate complex has fallen against the euro, dollar and pound sterling following the emergence of fresh Chinese concerns.

As we have said recently, China remains the engine for movements in the South African rand and fellow commodity-linked currencies such as the Mexican peso and Australian dollar.

The outlook suggests more of the same, leading us to retain a bearish view on ZAR.

The 10% drop in the Chinese equity market over the past two days, reflecting growing concern over the economy, has started to spill into global markets.

“Rising risk aversion has hit commodities, with the coal price notably falling to a 12-year low and risks spilling into high-yield currencies such as the rand,” says John Cairns at Rand Merchant Bank in Johannesburg.

Cairns cautions that there is no need to panic though, Chinese equities are still well off on their July low and the authorities have again set the yuan central rate largely unchanged from yesterday.

ABN Amro Downgrade Outlook for Commodity-Linked Currencies

The outlook for emerging market countries is however negative – and we see this as having a direct impact on the South African rand.

ABN Amro have told clients in a new currency forecast note that they have downgraded their Asian currency profile by an additional 2-3%.

“Overall, we expect the Singapore dollar, Taiwan dollar and South Korean won to be more vulnerable to a weaker yuan, while the Indian rupee should be less impacted. We have added the Singapore dollar into our high conviction list as we expect a cumulative underperformance against the US dollar of around 8% by the end of 2016,” says Roy Teo, Senior FX Strategist at ABN Amro.

Teo was ranked by Bloomberg as the most accurate forecaster for Asian currencies for several quarters in 2014 and 2015.

This year the performance of emerging market (EM) currencies has gone from bad to worse.

What explains the fall and what happens next?

One factor explaining the weakness is the substantial drop in commodity prices, which has hurt major commodity exporters (CRB has dropped by around 14% year-to-date).

Renewed weakness in oil prices driven by oversupply has weighed on the currencies of oil exporters such as the Russian ruble and the Mexican peso.

Furthermore, the change in FX policy in China has also unnerved EM currencies, especially currencies that export to or compete with China in terms of.

The Mexican peso and South African rand fall in this category.

Interest rate hike expectations in the United States and United Kingdom are forecast to underpin the pound and US dollar – we see the prospect of further gains in USD/ZAR and GBP/ZAR as being highly likely over coming months.

SA Inflation in Focus

Turning to the domestic agenda, headline CPI inflation is expected to have risen from 4.7% y/y to 5.0% in July, while core inflation should have eased from 5.5%.

There is downside risk to target inflation and we would not be surprised by a print below 5.0%.

"Given our view of sluggish underlying pricing pressures, we think there is only one more 25bp hike left in this cycle, to be administered in November of this year. As growth weakens and core inflation slows, the SARB will find it difficult to justify a steeper hiking cycle. Our forecast faces limited upside risk in the near term," says RMB's Cairns.

Without the help of higher interest rates the SA rand will likely struggle, particularly against the British pound and US dollar whom are facing upside pressures in the face of their own interest rate rises.