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Pound Tipped to Extend Uptrend vs. South African Rand, Budget Statement Dominates ZAR's Week Ahead

Mboweni in focus

Above: Finance Minister Tito Mboweni (right) is in focus midweek.

- GBP/ZAR extends uptrend as Rand weakens

- Continuation up to 18.55 now probable

- Eskom crisis seen undermining SA currency

The Pound-to-South African Rand exchange rate is trading over half a percent higher so far this week with the Rand seeing some weakness as traders take some exposure to the currency off the table ahead of Wednesday's South African government budget statement.

Investors are seen selling the South African unit ahead of the country's annual fiscal statement as uncertainty over the state of the national utility supplier Eskom, as well as the possible introduction of new laws on land reform, weigh on the outlook.

From a technical perspective, GBP/ZAR is now rising in an established short-term uptrend which is, by default, expected to extend higher as calling a trend reversal often tends to be a fools errand.

GBP to ZAR daily

Last week we noted the beginning of this potential uptrend after the pair concluded two higher highs and higher lows on the 4hr chart, but argued only a clear break above a resistance zone composed of the trendline and major moving averages (MA) would give the green light to an extension higher.

The pair has now successfully broken clearly above this resistance zone and is set to continue higher to a target at 18.55 and the December highs as well as the 200-week MA. Added confirmation might come from a break above the 18.31 February 18 highs.

One potential fundamental driver for the GBP/ZAR gains is the crisis currently dogging the country's principal energy supplier, Eskom, which is struggling to service its debts.

Eskom owes “R419bn which it cannot service from its own revenue,” says Thanda Sithole, economist at Standard Bank. “This lack of liquidity comprises the single biggest risk to SA's fiscal outlook and sovereign ratings.”

Eskom's financial difficulties have led to widespread power cuts which has curtailed the country's commercial activity, limiting growth. The fear is that this could lead credit rating agency Moody's to downgrade the country's rating to sub-investment grade when it conducts its review on March 29, which would in turn be disastrous for the Rand. A downgrade would be quite a drastic measure, however, and is not Standard Bank's base-case outcome.

This brings us to the main scheduled event of the week for the Rand which is the SA budget statement scheduled for delivery by finance minister Tito Mboweni on Wednesday, February 20. The budget is likely to include a bailout for Eskom.

Since government revenue has probably fallen the budget will also likely include spending cuts to offset the fall. How ratings agencies react to the budget will in turn impact on the Rand.

Last week we reported the Rand is at risk of fresh weakness during the months ahead according to economists at Investec Bank, who say South Africa could see the outlook for its credit rating downgraded if the February budget does not go according to plan.

Moody's, the last remaining agency to still have an investment grade rating assigned to South Africa, will want to see a credible plan to bring down the budget deficit and put state power utility Eskom onto a sustainable financial footing emerge from the February 20 budget.

The agency made its voice heard late last week, when it panned President Cyril Ramaphosa's annual State of the Nation Address for lacking sufficient detail on what the government plans to do about Eskom.

"The move paves the way for a more transparent group with more clearly allocated revenue and cost between business segments," Moody's said in a statement following the SONA. "However, in and of itself it does little to address Eskom's financial challenges."

Looking at the global picture, the U.S. Dollar is a major driver of the SA Rand. The two currencies are negatively correlated. The release and contents of the minutes of the Federal Reserve's (Fed's) February policy meeting could be key in this regard.

The Fed sets interest rates, the moves of which are a major driver of the U.S. Dollar. When rates rise - or are expected to rise in the future - it attracts greater inflows of foreign capital driving up demand for the currency in the process. A fall in rates has the opposite effect and can lead to outflows.

The Fed has adopted a more neutral stance on interest rates recently after fears U.S. economic growth has peaked. The Fed has been engaged in both interest rate increases and the process of ‘quantitative tightening’ (QT) whereby it stops reinvesting principal from expiring bonds into new bonds, and this is seen as having had a dampening effect on inflation and the economy.

The minutes will present a detailed account of the deliberations of the members of the Fed’s policy committee in relation to these concerns as well as the right Fed policy response.

It could also reveal whether they are likely to continue with a neutral stance or not. If the minutes suggest they will - as seems most likely - the Dollar could continue to trend with a subdued tone, and if that is the case the Rand could actually gain a boost.

“Another risk for the Dollar are the FOMC minutes of the January meeting. The Federal Reserve surprised many when it seemingly ruled out a rate hike in the near term and flagged potential changes to its balance sheet unwinding plans. Should the minutes corroborate the dovish shift, the dollar could face some increased downside pressure,” says Raffi Boyadijian, currency analyst at broker XM.com.

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