Rand Advances as Inflation and U.S. Dollar Decline but Where Next for South Africa's Currency?

Image © Comugnero Silvana, Adobe Stock

- ZAR rises as USD weakens and inflation surprises on downside.

- South African inflation fell in August, confounding market expectations.

- Data weakens case for SARB rate hike, ZAR outlook remains negative.

The Rand advanced against rivals Wednesday after official data revealed a surprise fall in inflation during August and as a declining U.S. Dollar offered a rare moment of respite to the South African currency, but few analysts expect these gains to endure.

South African inflation rose at an annualised pace of 4.9% during August, down from 5.1% back in July, when markets had looked for an increase to 5.2%. 

Core inflation, which ignores volatile food and energy items so is seen as a more accurate representation of domestically generated inflation pressures, also declined from 4.3% in July to 4.2% during August.

August's data came as a surprise to the market given the substantial near-3% rise in the USD/ZAR rate during that month, which should have had significant influence over the cost of importing goods. An 18% 2018 increase in the price of oil was should also have been at play, or so said the analyst community ahead of Wednesday's release.

"There was no clear evidence of second round, pass through effects from the rand’s depreciation yet in the CPI, but these could come through in September and October, given the delay in reporting – price pressures for the month are surveyed for the first week of that month and then back three weeks of the previous month," says Annabel Bishop, chief economist at Investec Bank.

Statistics South Africa data shows alcohol, tobacco and transport costs made a lesser contribution to inflation than they did back in July, accounting for much of the decline in the consumer price index, although there wasn't a single category of goods in which price pressures actually increased during the recent month.

Above: Statistics South Africa graph showing contributions to inflation in July and August.

"Despite the respite today, CPI inflation will likely continue to rise into 2019. While substantially higher fuel price increases are scheduled for October, it is uncertain how much the State will pass through, but the outlook for food prices could elevate depending on the next crop planting season," Bishop adds.

Markets care about inflation because it has implications for interest rates, which are themselves the predominant driver of exchange rates because of the influence that rising and falling returns can have on international capital and speculative money. It is inflation central banks are attempting to manipulate when they tinker with interest rates.

August's decline should mean an interest rate rise now becomes less likely, which would typically be bad news for a currency, but markets could have welcomed the data Thursday because it likely spares South Africa's recession-stricken economy from suffering the headwinds that would be posed by higher borrowing costs.

"The majority of analysts expect unchanged interest rates – as do we," says Esther Reichelt, an analyst at Commerzbank. "In view of the ailing economy - South Africa slid into recession in Q2 - the SARB is unlikely to want to act too quickly."

Above: USD/ZAR rate shown at daily intervals.

The USD/ZAR rate was quoted 1.29% lower at 14.67 at the London noon Wednesday but is up 18.5% so far in 2018, while the Pound-to-Rand rate was 1.49% lower at 19.27 but has risen 15.6% this year. 

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

Meanwhile, the U.S. Dollar index was 0.04% lower 94.56, placing the greenback on course for its second consecutive session of losses, and is now up 2.5% for 2018 after reversing a 4% first-quarter decline.

The Dollar has ceded ground since Tuesday due to market relief that President Donald Trump's latest tariffs aimed at China were not as severe as they could have been. This weaker Dollar environment is also supporting the Rand.

South African Reserve Bank, Rand, in Focus

Analysts have been warning of a pending increase in inflation given the Rand's double-digit depreciation and the steep rise in oil prices seen so far in 2018.

Those price pressures are still expected to threaten the upper end of the South African Reserve Bank (SARB) 3% to 6% inflation target and are a factor behind analyst forecasts suggesting policymakers will soon raise interest rates.  

"The weaker than expected CPI inflation outcome for August will alleviate the expected upward trajectory in CPI inflation for the rest of this year and into next year, thereby reducing the pressure somewhat on the SARB to hike interest rates this week, although globally interest rates remain in an upward cycle, particularly in emerging markets," Investec's Bishop concludes.

Changes in rates, or hints of them being in the cards, are normally only made in response to movements in inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

"At the July MPC meeting the SARB forecast that Q3 headline inflation would average 5.4% and core would average 4.7% - these forecasts are almost certainly too high. However, any comfort the MPC may take from today's data will be offset by the 9% fall in the rand in trade-weighted terms since the July meeting. But, on balance, we think the MPC will stay on hold tomorrow," says Cristian Maggio, head of emerging market strategy at TD Securities. 

The SARB will announce its latest interest rate decision Thursday and although few analysts expect it to raise interest rates this week, increasing numbers are forecasting that it will move before year-end.

Previously, before July, most had seen the SARB holding its cash rate steady at 6.5% until well into 2019. But severe losses for emerging market currencies including the Rand, due largely to a strengthening U.S. Dollar, have been a game changer for central banks in the developing world.

"We now expect to see the first interest rate hike in 4Q18 — compared to our previous call for rates to increase in 4Q19 — if the current global environment persists and the rand remains under pressure," says Mpho Tsebe, a currency economist at Rand Merchant Bank.

Tsebe says the SARB is likely to pull the trigger on a rate rise before the year is out but crucially, does not predict a policy change this week. If she is right markets may find themselves with little reason to bid for the Rand on Thursday, which suggests Wednesday's gains could quickly be unwound, although much will also be determined by the trajectory of the U.S. Dollar.

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