Rand Losses Becoming Problematic and South African Reserve Bank Rate Hikes are Now In Cards: Investec

-ZAR losses mean SARB inflation target is now under threat say Investec.

-At least one interest rate rise will now come from SARB before year end. 

-ZAR outlook is also hinged on government's handling of land reform.

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The Rand's 2018 losses have reached the extremes and an interest rate hike from the South African Reserve Bank (SARB) is now necessary to stabilise the currency and combat rising levels of inflation, according to Investec Bank. 

Investec's call comes as the South African Rand nurses a 20% loss against the US Dollar, an 18% decline against Pound Sterling and in the wake of a 10% 2018 depreciation in trade-weighted terms.

Politics have been among the chief causes of these losses. So too has US interest rate policy, which has raised the cost of borrowing and widened current account deficits across the developing world. Those deficits have also been made worse by an 18% climb, to $78, in the oil price this year. 

In summary, a perfect storm of adverse conditions has been brewing away above the emerging world throughout much of 2018 and South Africa is being pulled steadily toward the eye of that storm. Investec said Tuesday that what the South African Reserve Bank does next will be key to the outlook from here. 

"While the Reserve Bank has emphasised its characteristic of looking through volatile currency movements to the likely long-term impact on the inflation rate, even when the currency weakness is spread over a couple of months, the rand’s collapse has now been ongoing for four months," says Annabel Bishop, chief economist at Investec, in a note to clients. "Investec now expects at least one 25bp interest rate hike from the Reserve Bank by the end of this year."

The SARB will announce its latest interest rate decision on 20 September. It cut the cash rate by 25 basis points to 6.5% back in February but is now expected to raise rates in order to head off rising inflation, which has been coaxed higher by currency devaluation and the oil price change.  

Governor Lesetja Kganyago warned of "upside risks" to the inflation outlook back in July and since then the main consumer price index (CPI) has risen to 5.1%, up from 4.6% back in June. The SARB is obliged to use monetary policy to ensure that CPI remains somewhere between 3% and 6%.

The governor also said the bank will act if consumer prices deviated "significantly away from the midpoint of the inflation target range". Bishop says the ongoing depreciation of the Rand could force the SARB to raise its forecast for 2019 inflation from 5.6% to 5.8% this month. 

"A 25bp hike has become increasingly likely at the September MPC meeting, but may be pushed out until November on SARB concerns over economic growth. However, the recession is historical, and Q3.18 should show a rebound in economic growth," Bishop writes. 

Beyond inflation forecasting, the tough part for the SARB over coming weeks will be deciding whether to risk further hobbling South Africa's recession-stricken economy, or risk seeing consumer prices exceed its inflation target at a later date. South Africa slipped into recession this year when the economy contracted for the second consecutive quarter, with growth falling -0.7% during the three months to the end of June after having declined -2.6% in the opening quarter.  

Bishop and the Investec team say there are two main scenarios, each with an almost equal probability, that could play out over coming months.

The first has a 40% probability and would see the SARB raise interest rates twice and the USD/ZAR rate decline back to 12.70 by year-end. This would be a substantial correction of the Rand's year-to-date loss. 

The second scenario, with an estimated 35% probability, is the SARB raises interest rates no less than four times and yet despite this, the Rand still loses further ground. USD/ZAR rises to 16.20 in this instance. 

The difference between the two, beyond interest rate and currency forecasts, is the government's handling of its controversial land reform programme.

If it expropriates land from "certain groups", particularly productive agricultural land, without compensation and international investors become spooked by this then Bishop says the second scenario would be likely to play out. 

The ruling African National Congress and a majority in South Africa's parliament are seeking constitutional reform to legalise the expropriation of land without compensation for owners. 

The Expropriation Act was designed to placate the radical Economic Freedom Fighters grouping of the parliament but along with casting President Cyril Ramaphosa's grip on power in a much weaker light, it also places a question mark directly over South Africa's commitment to private property rights.

Local press reported this week that South African farm prices have fallen nearly a third since February, citing the land programme as the cause. 

Statistics South Africa said in its GDP report that agricultural production declined 29% in the second quarter after already having plummeted 33.6% during the first three months of the year.  

"This was largely driven by a decline in the production of field crops and horticultural products. Continued drought conditions in Western Cape and a severe hailstorm in Mpumalanga, resulting in extensive crop damage, also placed additional pressure on production in the second quarter," the agency writes. 

The USD/ZAR rate was quoted 0.71% higher at 15.16 Wednesday while the Pound-to-Rand rate was 0.62% higher at 19.70.

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