Summary:
- South African currency strengthens following remarks from the central bank giving hopes for rate hikes in the foreseeable future
- May inflation report comes in below expectations, odds for a hike this year move back
- Market-based inflation expectations are running at their 7-month high
The South African currency is gaining momentum today even as the May inflation report came in below market expectations. The upward move is mainly driven by the latest remarks offered by the country’s central bank hinting at possible rate hikes once downward pressure on the ZAR does not subside. Notice that since March the USDZAR has surged from 11.62 to 13.90 making the SARB position more uncomfortable as the currency depreciation may soon translate into higher domestic price pressures.
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South African inflation keeps running around the target, but risks might skewed to the upside. Source: Macrobond, XTB Research
Kuben Naidoo, the SARB’s deputy governor, said on Tuesday in Sintra, Portugal that "if we do think there is a risk of second-round effects, we will have to act" admitting at the same time that the central bank does not target a specific level of the rand. The bank forecasts inflation should stay within the desirable bounds between 3% and 6% until at least the end of 2020. On the other hand, those risks have yet to materialize as the May’s inflation report showed price growth slowing to 4.4% from 4.5% falling short of expectations placed at 4.6% in annual terms.
Expectations as for rate hikes for this year have receded following the May’s inflation release. Source: Bloomberg, XTB Research
In response to the data the rand pared its gains as odds for a rate increase this year diminished noticeably (the spread between 6x9 FRA and 3-month money market rate plunged from 34bps to as low as 24bps) suggesting the bank may have to pull the trigger just once till the end of 2018. Having said that, currency traders have not been spooked for longer, and even as FRA rates have not managed to trim their losses, the rand has regained ground.
In spite of the fact that inflation missed the consensus in May market-based inflation expectations keep running around their 7-month high. It needs to be said that the quickest rand depreciations has taken place in June so far, hence inflation reports for this month onwards might be impacted by currency effects. Naidoo noticed that if the currency comes back to 12.50 against the dollar during a month, it will have a much lower chance of causing inflation. The USDZAR is trading at 13.6703 as of 10:59 am BST Wednesday.
The weekly chart seems to offer quite an encouraging view for buyers as the pair has run into a resistance placed a notch below a 14.00 handle. A 38.2% retracement is also moving around this level offering more support for sellers. If Naidoo premise is to come true, the pair might decline toward a support nearby 12.40. Source: xStation5
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