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South African Rand Hits Fresh 2018 Lows but the SARB Could Soon Step in to Save It

- Rand falls to 2018 lows vs the Pound and Dollar in June.
- Fed and market doubts over SARB policy the latest challenge.
- Analysts say SARB will raise rates soon, supporting the Rand.

© Goroden Kkoff, Adobe Stock

The Rand weakened against Pound Sterling Tuesday as domestic and offshore factors saw traders shun the currency although, according to some analysts, the South African Reserve Bank (SARB) may soon step in to save it from further losses.

The Pound-to-South African Rand rate reached new 22018 highs of 17.80 last week, establishing itself well above the previous range highs of 17.40, as investors shunned emerging market currencies and South African GDP data for the first-quarter underwhelmed the market.

This is notable because the Pound hasn't risen against many other currencies of late but it could continue to advance against the Rand this week as if strategists are right and the US Federal Reserve boosts the Dollar by raising its interest rate again on Wednesday.

The Rand is negatively correlated to the US Dollar, like all emerging market currencies, because so much domestic debt is denominated in Dollars. As a result, when greenback rises the cost of servicing that debt goes up, placing pressure on the public finances and augering increased outflows of funds further down the line.

"Outflows reached an average of 1.6 billion rands ($122 million) a day in the past month, and show no sign of abating. That’s weighing on the rand, as South Africa relies on portfolio flows to finance a persistent current-account deficit," says Robert Brand, a reporter for Bloomberg News.

Investors are already fleeing the South African debt market in their droves so a Federal Reserve inspired sell off on in the nation's government bonds, which would be likely if US rates rise and bonds fall, will only intensify the pressure on South Africa's currency.

The yield on 10-year South African government bonds sat at 9.0% on Tuesday, 600 basis points above the 3.0% offered by 'safe-haven' US 10-year bonds, and although this might seem a sizeable risk premium its not as attractive as those offered by competitors such as Turkey and Brazil. Bonds from those countries offer yields of 12.30% and 11.68% respectively.

South Africa narrowly avoided having its credit rating downgraded to junk status at the start of the year so this may explain the lower yield relative to sub-investment grade Turkey and Brazil. But a weakening domestic economy and offshore factors leave both the nation's bonds and currency looking like a risky prospect vulnerable to fresh losses.

"The combination of global risk-off sentiment and weak domestic data has probably made investors nervous," says Thu Lan Nguyan, an analyst at Commerzbank. "The imminent Fed rate hike and concerns about a global trade war, that would also affect the South African economy, are creating depreciation pressure."

Nguyan says one reason for the recent Rand weakness might be concern in the market that the South African Reserve Bank (SARB) will be hesitant to support the currency and balance inflation risks by raising its interest rate. After all, higher interest rates would only serve to weaken an already fragile economy.

Central banks in Turkey and Brazil both hesitated to take action in the last month, which saw their respective currencies crushed beneath a wave of outflows and speculative short selling. 

But Nguyan flags that the SARB also told markets back in May that interest rate cuts were now off the agenda and signalled it could be willing to tighten monetary policy over the coming months.

And if anything, the recent fall in the Rand back to 2017 lows only serves to make rate hikes more likely because a weaker currency lifts inflation by making imported goods more expensive to buy.

"Due to continued ZAR depreciation the risks for inflation have intensified. We assume that [the SARB] will react accordingly so as not risk its credibility and to control rising inflation expectations. This would support the rand," Nguyen writes, in a briefing Tuesday. Bloomberg's Brand is of a similar view.

"Nobody is expecting the South African Reserve Bank to step in to support the rand; it hasn’t done that in two decades. But currency weakness feeds through to inflation, and that may force the central bank’s hand," he writes, in a recent article.

He also says traders are already pricing in a greater probability of a rate hike as the Rand weakens, with 20 basis points now already priced in (0.2%).

The USD/ZAR rate was quoted 0.75% higher at 13.25 Tuesday while the Pound-to-Rand rate was 1.09% higher at 17.78.

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