23 Jan 2018

Rand note: Rand pierces key R12.00/USD level, driven by USD weakness and ongoing positive sentiment towards SA aided by many leaders comments at Davos

Annabel Bishop

Chief Economist

  • The rand convincingly pierced the R12.00/USD key resistance level today, reaching R11.92/USD as the US dollar weakened on US economic policy concerns, with the greenback reaching around three year lows, following also ongoing revelations on US political issues. 
  • Positive comments from SA officials in Davos on ending corruption, repairing SOE governance and the health of public finances, maintaining SA’s key institutional strengths and promoting economic growth have also assisted in the lift in the domestic currency. 
  • The rand reached R14.73/EUR and R16.81/GBP today versus yesterday’s close of R14.84/EUR and R16.92/GBP, showing some small strength against the crosses as Dovos proved to take centre stage. 
  • However, on a trade weighted basis the rand is only about 3% stronger y/y as it was at R14.48/EUR, R16.85/GBP and R13.47/USD on 23rd January 2017, with the weighting of the euro and GBP higher in this basket than the USD. The MPC looks at the trade weighted rand in its inflation analysis, with headline inflation a y/y measurement.
  • Today’s rand strength on its own does not herald interest rate cuts, as the SARB targets inflation in six to twenty four months’ time when it makes its interest rate decisions, and the currency’s strength would need to be expected to be sustained by the MPC.
  • The effects of recent rand strength, if not sustained, are expected to wear out quickly in the first quarter as far as the impact on fuel prices goes, and then have less impact on CPI inflation longer-term as many retailers will likely use the domestic currency’s strength to claw back the impact of their previous absorption of upwards price pressures following marked currency depreciation in earlier years. 
  • CPI inflation is expected to bottom just below 4.5% in Q1.18 (which is not the SARB’s inflation targeting period), and then climb over Q2.18 towards 5.0%, then exceed 5.0% y/y in H2.18, remaining above 5.0% y/y in 2019 and running at 5.5% in 2020. This ascent from the trough in Q1.18 is expected to be driven by base effects, commodity price pressures and some improvement in domestic demand which would place upwards pressure on CPI inflation. 
  • Of interest, the rand can strengthen temporarily on a somewhat higher inflation print, as occurred today, as higher interest rates can mean higher yields and traders can see increasing CPI inflation as heralding higher interest rates. However, the SARB targets inflation six to twenty-four months out so will not be looking at today’s CPI print in its future interest rate decisions.    
  • The next key resistance level for the rand (after minor resistance at R11.90/USD) should be R11.70/USD (see “Oil note: communications of an early exit for Zuma, and the start of repair at Eskom, strengthen the domestic currency, signalling further petrol price cuts”, 22nd January 2018, website address below).
  • Risks for rand weakness remain. The budget on 21st February 2018 will be watched by the rating agencies for both fiscal consolidation and the avoidance of excessive tax hikes that strangle economic growth. Moody’s, the last key agency which has SA on investment grade, is set to deliver a downgrade after the budget if the above priorities are not met, and if insufficient progress has been made on SOE governance reform. 
  • On a cautionary note, should SA lose its last key investment grade rating, and drop further down the sub-investment grade rating ladder, then the rand could see substantial weakness, moving back towards R13.50/USD with similar weakness against the crosses.