The rand’s slide to its lowest point since 2001 isn’t proving to be as big a headache for South African policymakers as it was the last time the currency was in freefall.
Two years ago, the South African Reserve Bank estimated that every 10% decline in the rand boosts the inflation rate by two percentage points. While the bank still cites the rand as the main inflation risk, it now estimates that the pass-through effect of a weakening currency on consumer prices may be about half of what it initially assumed.
Inflation-linked bonds suggest that investors aren’t so worried either, as the rand heads towards 13 to the dollar. The rand’s more muted effect on prices, mainly a result of weak demand in the economy and increased competition among retailers, is benefiting the inflation outlook at the same time that oil prices trade near a six-year low of $50 a barrel. That gives Reserve Bank governor Lesetja Kganyago scope to limit rate increases in an effort to support an economy hit by power shortages, falling commodity prices and strikes.
Dave Mohr, the chief investment strategist at Old Mutual Wealth, said: “We’ve had petrol price shocks and food price shocks and a huge exchange rate shock, but core inflation actually behaved itself quite well. That shows that the economy is less inflationary than what traditional models show.”
Core inflation eased
Core inflation, which excludes a broad group of food and energy costs, eased to 5.4% in July, the lowest in 17 months, the statistics office said on Wednesday. Headline inflation accelerated to 5% from 4.7%, in line with the median estimate of 25 economists surveyed by Bloomberg.
The five-year break-even rate, a measure of bond investors’ inflation expectations in the period, fell five basis points this month to 6.53% even as the rand slid 2% against the dollar. That compares with a 20 basis point increase in the same period in Turkey, one of South Africa’s emerging-market peers.
Investor expectations of another interest rate increase have barely budged this year, despite the currency’s weakness. The central bank raised its benchmark repurchase rate in July for the first time in a year to 6%, as it forecast inflation will exceed the 3% to 6% target band for the first half of next year. The bank’s current interest rate tightening cycle will be moderate, Kganyago said.
Head of fixed-income investments at Cadiz Asset Management Jonathan Myerson, said: “Oil is coming down and inflation forecasts will probably be revised downwards a bit on the basis of that.” There’s a chance of another interest rate hike this year if the United States Federal Reserve tightens monetary policy, he said.
The rand gained 0.1% to trade at 12.8962 per dollar on Wednesday, taking its decline since the start of the year to 10.3%, but this will not necessarily lead to an inflation problem, said Elize Kruger, an economist at KADD Capital. – Bloomberg