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The rand is up to its old tricks

31 July 2008 Gareth Stokes

Just when you think the rand has given up the fight it finds a second lease on life. That’s what we’ve seen in recent weeks as the local currency struggles back to its best level against the US dollar in some six months. As we pen this newsletter the currency remains pegged below R7.40 to the dollar – an 8% improvement since falling to R8.17 in March. But what’s the reason for the rand’s sudden resurgence? Shouldn’t our currency be on the back foot if all the other economic indicators are in such a state?

Economics is never that simple. The irony is that the cause of the current South African consumer nightmare is also behind the latest round of rand strength. Because rising local interest rates (the Reserve Bank’s response to high inflation) make it extremely attractive for offshore investors to ‘park’ funds in South Africa. Economists refer to this activity as carry trade – and over the last six to eight weeks the rand has offered the best carry trade return against the dollar, Euro and Yen of any other major currency...

More headaches after latest inflation data

As long as local interest rates remain high the rand will benefit from inflows of yield seeking capital and trend stronger. And since inflationary pressures have not receded there’s little hope of a softening of local monetary policy any time soon. The latest figures from Statistics South Africa confirm this. CPIX (prices with the impact of mortgage interest stripped out) came in at 11.6% year-on-year to June 2008 – worse than economists’ worst-case scenario of 11.3%. It’s also 15 months since CPIX inflation broke through the Reserve Bank’s six percent upper inflation target.

We can find some glimmers of hope among all this gloom. Thanks to Investec we know that Statistics SA will be using a different basket of goods and services from January 2009 which should ‘lower’ inflation by approximately 200 basis points. We’re sure the Monetary Policy Committee will keep this point ‘top of mind’ when they meet to decide interest rates in August. Analysts are playing their usual guessing game as day draws nearer. Before yesterday’s shock inflation number most of them expected Tito Mboweni to leave rates unchanged...

Fortunately one of the main drivers of global inflation has taken its foot off the accelerator in recent days. The per barrel price of Brent crude oil has slipped below $125. We can’t say for how long it will remain there; but at least there’s some relief from surging fuel prices in the short-term. The combination of lower oil and a stronger rand should give scope for some petrol price relief in Augusts and September.

Where to from here?

Although the rand is showing strength in the short-term its fundamentals remain weak. South Africa has a huge current account deficit which can only be sustained by massive foreign capital inflow. As long as these inflows remain of a temporary nature the currency is vulnerable to any sentiment shift on South Africa’s prospects. If investors get jittery they can move their ‘parked’ funds out of the country in an instant – putting tremendous pressure on the rand. A Rand Merchant Bank economist told I-Net Bridge that they would maintain there R8.50 to the dollar target for the rand at year end. And it seems larger investment houses share this view.

Where inflation is concerned it looks like we’re still in a rising trend. We could see CPIX, as measured by Statistics SA, peak at around 13% before the end of the year. It remains to be seen whether local inflation trends higher despite a slowdown in the oil price. If that happens the argument that inflation is being caused by factors outside the Reserve Bank’s control might fall flat – and we could see another rate hike before Christmas.

Editor’s thoughts: Since December 2004, when the rand touched R5.65 to the dollar our currency has been in steady decline. This is one of the expected results of the large difference in interest rates between SA and the United States. In the last 12 months the rand has traded in a R6.50 to R8.17 band with a bit more volatility than the preceding period. Where do you think the rand will be by the end of this year? Add your comments below, or send them to gareth@fanews.co.za

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