South Africa’s rand has firmed to levels that may add to central bank concerns about the current account deficit and raise doubts about the wisdom of pushing through more interest rate hikes.
Raising rates further, as the Reserve Bank is widely expected to do next month, could enhance South Africa’s carry trade credentials among investors hunting for higher yields, and so bolster the rand — already at an 11-month high against a weak dollar.
”This is one of the reasons why we are questioning whether the Reserve Bank will, in fact, raise rates,” ETM analyst George Glynos said. ”People are making it sound like a forgone conclusion, but I don’t think it is.”
South African official rates are already at 9,5% — compared with 5,25% in the United States and just 0,5% in Japan.
The Reserve Bank may not want to strengthen the rand, or keep it as strong, by boosting its value in carry trades, where lower-yielding currencies are used to invest in high yielders.
The rand’s rebound this year will hit South Africa’s exporters and add to concerns about a current account that is deep in the red, albeit easily financed by capital inflows.
The gap, a key measure of economic vulnerability, narrowed just slightly to 7% of gross domestic product in the first quarter of 2007.
The rand was last trading on Tuesday at 6,8250 to the dollar, a gain of more than two percent in 2007 and well off its 2006 low of 7,98.
The central bank is believed to be uncomfortable with the currency stronger than seven to the dollar. Central bank Governor Tito Mboweni said in May the unit — then at seven — was ”out of kilter” with the trade imbalance.
It could still strengthen further, given the global appetite for riskier assets like those from South Africa, and gains generally in emerging markets.
A break through the 6,80 per dollar level could lead to a test of 6,73/75, Glynos said, although there was risk of a reverse should US stocks fall or the dollar pull back from its current near-record lows.
Others said it was unlikely to gain significantly.
”The rand always seems to be a reluctant rallier: it is always lagging the others [emerging market currencies],” Royal Bank of Scotland’s Lucy Bethell said.
Serious about inflation
The bank’s primary concern is CPIX inflation, which pierced its 3% to 6% target band in April and edged up again in May to 6,4% year-on-year. June’s figure — due out on Wednesday — is forecast at 6,3%.
Mboweni has repeatedly complained that consumers are spending too much, evident in year-on-year credit demand that is still near record levels of around 25%.
Rising inflation and only tentative signs demand is easing has cemented market predictions, reflected in the strong rand and weak government bonds, of at least one more rate rise, probably at the next policy meeting on August 15 to 16.
But the currency’s rally may have raised doubts.
”Investors may want to think twice about the one-dimensional consensus expectation that rates will simply have to be raised as a prudent course of action,” Glynos said.
The firmer rand may act to tame imported inflation, and a new law clamping down on credit providers that came into effect in June effectively serves as a tightening of monetary policy.
”The NCA [National Credit Act] … prevents people taking on extra credit,” he said.
Some in the market may be open to the argument: banking shares were the biggest gainers on the Johannesburg stock market on Monday, adding more than 3%. The banking index ticked up further on Tuesday.
”There’s a rumour there won’t be another rate hike based on the strong rand,” Tubby Goodwin, equities trader at Investec Securities, said in explaining the gains.
However, those expecting another rate hike say the Reserve Bank has to be seen to give priority to reining in inflation.
”That is where their policy credibility lies,” said Razia Khan, head of research for Africa at Standard Chartered Africa in London.
”With oil touching $80 [a barrel], we do not get the sense that the SARB have a huge problem with current rand strength … A strong rand does not hurt,” she said. ”We’d have to see much more of a move, maybe to sub 6,40, to prevent the SARB from hiking again.” – Reuters