22 May 2018

Economic activity buoyant despite weakened rand

Annabel Bishop

Podcast

What does the weakened rand and rise in consumer and business confidence mean for GDP growth and investment in South Africa?

LISTEN TO PODCAST: What does 2018 look like for the rand?

Weakened rand and increased confidence
Investec's Chief Economist Annabel Bishop discusses the rand's performance in recent days as well as the rise in sentiment towards the country, including consumer and business confidence, and what this means for GDP growth and investment in the country.

Topics of discussion:

 

  • This week, the rand weakened to its lowest level in nearly six months. What have been the contributing factors? Can we expect an improvement and, if so, when?
  • What have been the main effects of the weakened rand?
  • Consumer confidence in the country was recorded at an all time high in the first quarter of 2018. How did we get here? And what can we expect in the next quarter?
  • Business confidence rose in the first quarter but not to the same extent consumer confidence did. While evincing a big jump, it is still below the neutral 50 mark. Could you unpack this for us. 

ZARGBP summary notes

R16 again, and lower?
  • After reaching a historic high of R24.69/GBP (4 pence) in January 2016 the rand steadily appreciated against the GBP, reaching R15.32/GBP in March 2017, although since then has tended to move closer to R16.50/GBP.  Political uncertainty in SA and global risk-off were some factors driving the low.
  • The GBP has been roiled by Brexit concerns, reaching a historic low of USD1.18/GBP towards the end of 2016. With resolutions to the path Brexit will follow still unresolved, June 2018 will see the European Union Withdrawal Bill before UK Parliament.
  • Brexit has gained renewed focus, with a GBP volatility risk in the period ahead. The rand is likely to be beset by volatility again in the ramp up to a neutral real US interest rate (see "Rand note: since the global financial crisis, to April 2018, US$2.5trillion flowed into EMs in a relatively low US interest rate environment – but as the transition to neutral US interest rates becomes more advanced, the risk of outflows is heightened", 21st May 2018, website address below).
  • The soft Brexit option sees the UK remain relatively aligned with the current trade system (varying degrees proposed) while a hard Brexit would (mostly or completely) break with the system. With the Brexit process already begun in March 2017, a weak period for the GBP, the UK has just under a year to renegotiate trade relations with the EU.
  • A hard Brexit is not necessarily expected, but then neither was Brexit itself. Indeed, the BOE has said Brexit is the UK’s "biggest domestic risk to financial stability", with the Central Bank stress testing scenarios on its financial institutions in the run up.
  • GBP weakness is likely on a hard BREXIT. Indeed, the ZAR may strengthen through R16.00/GBP towards R15.00/GBP if cable weakens substantially, and US rate hike expectations do not re-elevate simultaneously.
  •  The purchasing power parity (PPP) valuation of the rand to the UK pound of around R14.00/GBP, shows a substantial departure from fair value which occurred from 2011/2012 onwards, when PPP was around R10.90/GBP and the exchange rate similar.
  •  While the rand tracks back towards PPP in times of neutral to risk-on events, the PPP measure (driven by inflation differentials) could depreciate to close to R15.00/GBP by 2020. Currently the domestic currency is at R16.61/GBP, R14.55/EUR and R12.41/USD as it tracks closer to the expected case against the USD.
  •  While SA is not expected to necessarily see direct financial turbulence due to a hard Brexit, risk-off would likely rise, a negative for EMcurrencies. Furthermore, the anticipated sharp fall in UK confidence measures would negatively impact UK growth, with the EU not expected to escape unscathed.
  • The most recent FOMC minutes show both the appetite for another 25bp hike in the near term (probably June FOMC meeting), but also highlighted the tolerance of inflation modestly exceeding its informal target. Market fears have subsided somewhat on the US rate front.
  • With a perceived less hawkish FOMC tone, and debate increasingly pointing to a lower as opposed to higher neutral US interest rate (closer to 2.5% than 3.5%), the expectations for further US rate hikes have also calmed.
  • With the heat likely taken out of the FOMC meeting on 13thJune,  the rand is unlikely to see further weakness against the US dollar from this perspective, unless FOMC members make an about turn in communication. Indeed, discussions on the level of the neutral interest rate may come to the
  • fore instead.
  • The IIF shows a mild reversal in EM investor flows from the recent sell-off (from early this week and last), but not yet a notable trend. The rand has seen inflows of R0.2bn since Tuesday, but this could lift when today’s data is published.
  • With the UK pound at risk of weakness depending on the direction of Brexit discussions in June, at a time when investor appetite for EM assets may pick-up, ZARGBP strength could result. However, unless a hard Brexit becomes reality, PPP is an unlikely result. 
  • In South Africa, the Central Bank has left its repo unchanged today, citing increased risks to the inflation outlook due to global events, as expected. In particular, the MPC recognised that the “(t)he global economic backdrop has become more challenging amid continuing trade policy tensions between the US and China as well as other geopolitical risks.”
  • The SARB adds, “in the near term, the rand is expected to remain volatile, with movements dominated by the changing assessment of these global trends. Domestically, an expected moderate widening of the current account deficit, a result of deteriorating terms of trade, could also weigh on the rand.” 
  • Specifically, this concurs with our views that “a key uncertainty relates to the outlook for the dollar, which has appreciated against most currencies. The spillover effects on emerging markets could become more severe in the event of further significant increases in US bond yields.” We continue to expect no change in SA’s repo rate this year.
  • Indeed, the Committee adds that risks and uncertainties are now at high levels, our view which led to an increased tilt in our risk weights to the downside on 17th May, see “MPC preview: an unchanged interest rate decision is likely in May 2018, with higher interest rates more likely in the longer term”.