South African Rand Outperformance Benefits from SARB Inflation Decline

“The SARB is set to continue tightening the anticipation policy, which would imply that the neutral rate of 7.00% (according to the Bank’s model) could be reached much sooner than projected by its own forecasts. of the bank”, – Matrix Fund Managers.

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The South African rand outperformed all peer currencies ahead of the weekend and barely a day after the South African Reserve Bank (SARB) sought to lower domestic inflation expectations and push back currency depreciation. currency with its biggest interest rate hike in two decades.

The rand rose against all G20 currencies traded on the open market on Friday, with its biggest gains coming from its European counterparts as well as the Korean won, Indian rupee and Turkish lira, many of which fell further one percent compared to South Africa. currency.

“While we expected the SARB to be more sensitive to the fragile domestic growth backdrop, the bank is firmly focused on inflation and ensuring its credibility remains intact,” said Carmen Nel, Economist and Macro Strategist at Matrix Fund Managers.

Above: South African rand against G10 currencies on Friday. Source: British Pound Live.

The rand’s strong performance on Friday came on the heels of the Reserve Bank of South Africa’s decision to raise its benchmark rate from 0.75% to 5.5% in a larger monetary policy measure than many economists and a large part of the financial markets had not expected.

Governor Lesetja Kganyago cited recent currency depreciation as well as rising food and fuel prices as reasons why labor costs and society’s expectations for inflation rates futures rose, and it was these latter factors that catalyzed Thursday’s SARB decision.

“The highly volatile price of oil, an important imported commodity, together with the weak domestic currency remain a major upside risk to the inflation outcome, through its effect on fuel prices. The SARB now forecasts fuel price inflation for 2022 at 38.9% (from 31.2%),” says Lara Hodes, economist at Investec.

Above: The South African rand against other G20 currencies on Friday. Source: British Pound Live.

The SARB said little on Thursday about the latest prescription offered by its quarterly projection model for the cash rate, which had previously advocated a “gradual” return of the interest rate to more normal levels.

But parts of Governor Kganyago’s policy suggest the odds have recently shifted in favor of further increases in the cash rate and some market professionals see the SARB as likely to ‘preload’ or advance policy moves that would otherwise could be left until 2023. or later.

“Given that the peak of inflation in the rest of the world is not yet in the base, the SARB should continue to tighten its policy at the start of the period, which would imply that the neutral rate of 7.00% (according to the Bank’s model) could be reached much sooner than predicted by the bank’s own forecasts,” says Matrix’s Nel.

Above: Pound to Rand exchange rate displayed in hourly intervals alongside USD/ZAR.

“This would still be below the 8.00% to 8.50% level implied by Forward Rate Agreements (FRAs), which assign a substantial risk premium in light of the highly uncertain outlook,” she said. added about the “neutral rate” estimate. .

Matrix Fund Managers’ Nel said on Thursday that the pace at which the SARB is likely to raise interest rates will likely depend on the policy actions taken by the Federal Reserve (Fed), which has pledged to raise U.S. interest rates to a “moderately restrictive” level by the end of the year.

Fed policy has a significant influence on all currencies, although it may also be relevant that Thursday’s decision at the SARB also came on the heels of the European Central Bank’s first interest rate hike. for over a decade.

Above: Sterling to Rand exchange rate shown at daily intervals alongside USD/ZAR.

“Given a significant and persistent breach of the SARB’s 3-6% target range, we now expect policy rates to peak at +6.50%, with the speed of the tightening largely dictated by the Rand momentum,” said Kevin Daly, co-head of CEEMEA economics at Goldman Sachs.

“We believe the SARB is unlikely to react to weak growth in the face of higher inflation and currency risks,” Daly also said on Thursday.

Meanwhile, Friday’s rally in the rand took place in a market characterized by a general decline in US dollar exchange rates and underperformance in European currencies following the latest S&P Global PMI surveys on the manufacturing and services sectors. from the continent.

European indices for the manufacturing and services sectors fell further during the month of July and reached levels generally compatible with a recession.