Rand May Receive a Lift from the South African Reserve Bank Next Week say Commerzbank

-SARB to floatt rate hike Thursday, support ZAR, say Commerzbank

-But rates won't rise until 2019 as economy is too weak right now.

-ZAR to depreciate further against USD, GBP before year-end.

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The Rand could receive a boost next week if the South African Reserve Bank throws it a lifeline during Thursday's interest rate announcement, according to analysts at Commerzbank, although any respite for the currency is likely to prove short-lived.

The SARB will announce its latest monetary policy decision at 14:00 next Thursday and is widely expected to keep the country's main interest rate unchanged at 6.5%, although markets will scrutinise the bank's remarks closely for clues on the next likely policy move, given a domestic economic situation placing competing demands on the central bank.

South Africa's current predicament makes a case for both higher and lower rates. Economic growth has faltered this year at a time when current inflation is steady around the midpoint of the SARB's 3% to 6% target band, which might be enough to aughur an interest rate cut in more ordinary times.

But the Rand has plummeted in recent months due to offshore factors and the SARB may soon be forced to follow its emerging market counterparts in raising interest rates to defend the currency and stave off a surge in inflation later this year or next. A falling currency lifts inflation by making imported goods more expensive to buy.  

"That means the SARB’s communication on extent and timing of future rate steps is turning into a tightrope walk. We expect the SARB to keep its key rate on hold at 6.5% next week, it will, however, be on guard due to increased inflation risks and will stress its willingness to take action," says Elisabeth Andreae, an analyst at Commerzbank. 

South Africa's Rand is now down by close to 10% against the Dollar and more than 5% against the Pound for 2018 but, given it had risen by a similar measure during the first-quarter, it has actually fallen by an even greater degree since the middle of April.

Unease across financial markets over President Trump's "trade war", as well as a US economy that is going from strength to strength, have seen the Dollar emerge resurgent from the depths of a bear market this year. This has been bad for the Rand because 45% of South African government debt is owed to foreigners, with much of it denominated in US Dollars, which means those debts are now more expensive for the fiscally challenged South African government to service.

"Moreover the current account deficit has increased again significantly at the start of the year following a notable improvement in the years before. Weak growth is one of the main factors making the required consolidation of the public [finances] and some of the financially stricken state-owned companies more difficult. This increases the likelihood of a rating downgrade which would create additional depreciation pressure on the rand in a riskoff environment," Andreae writes, in a note to clients. 

South Africa is a prime target for speculators in a "risk off" environment, which often sees emerging market currencies dumped in favour of safe-havens like the US Dollar and Japanese Yen, given the government runs a budget deficit of around 4% of GDP.

This deficit must be funded by domestic and international borrowing. However, if taken to extremes, routs in emerging market currencies and bonds can sometimes see countries struggle to secure new funding from international lenders, which heaps further pressure onto their economies.

"The fragile economy on the one hand and the susceptibility of the rand to global risks on the other put the central bank between a rock and a hard place. The prospect of rate hikes can dampen the depreciation pressure while higher financing costs would put additional pressure on the economy. This is reflected in the so far rather cautious rate hike expectations on the market," Andreae adds.

Andreae also says that should the SARB hint next week that it will raise rates if the depreciation continues during the months ahead, then it could provide some respite to the Rand. Although her official forecast is for the Bank to actually eschew a rate rise until next year and for the currency to weaken further before the end of December.

The USD/ZAR rate was quoted 0.08% higher at 13.33 Friday while the Pound-to-Rand rate was 0.32% lower at 17.49. Andreae and the Commerzbank FX team forecast the USD/ZAR rate will rise to 14.25 before year-end, implying more losses for the Rand. The Pound-to-Rand rate is expected to rise to 18.83.

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