The rand has shown some real spirit this month. GBPZAR started July above 15.50 and reached a high of 15.87 on 1st July. Since then, the cross has spent the majority of the month trading below 15.50 against the pound. As this article is being written the rand is threatening to break back below the psychologically important 15.00 level but hasn’t quite made it. Despite this resistance to fundamental factors the outlook for the rest of the year remains bearish and, as with this ever-volatile currency, there will almost certainly still be opportunities to buy the rand at better value as the year draws on.
One of the reasons that the cross is not higher is sterling’s weakness across the board. Economic data releases from the UK make for pretty gloomy reading and with asset prices falling and inflation rising there’s not a lot of steam behind sterling. Save for its present value against the US dollar, the pound is weak against most other currencies. The Bank of England has kept interest rates at 5% in the UK but faces the dilemma of how to move rates next in an attempt to somehow bring domestic inflation under control without tipping the economy over the edge and into recession. Any support sterling has received from the recent upturn in domestic financial stocks is likely to prove short-lived. Reports that the U.K. Treasury is about to increase its borrowing to help fund the economic downturn is likely to knock the pound back again. There's a possibility that the pound could actually hold up against the dollar, and continue to hover around the $2.00 level as the U.S. currency itself comes under selling pressure. Elsewhere, however, the pound can be expected to slide.
Interest rates in South Africa have been raised consistently to the lofty and painful highs of 12%. The effect of the expanding differential between UK and SA rates causes the rand to appreciate against the pound. Investors buy rands to profit from the
higher yields on rand-denominated investments and the demand for rand causes it to appreciate. This is known as a ‘carry trade’ and here’s an explanation from investopedia.com:
‘A strategy in which an investor sells a certain currency with a relatively low interest rate and uses the funds to purchase a different currency yielding a higher interest rate. A trader using this strategy attempts to capture the difference between the rates - which can often be substantial, depending on the amount of leverage the investor chooses to use.’
The high gold price is also supporting the rand but over the medium-term we should see some rand weakness nonetheless. As I’ve noted in this column before the rand is prone to volatile price swings and with domestic inflation, measured by CPIX at 10.9% in May, the Reserve Bank may continue raising rates which in turn will have the effect of slowing the economy down.
South Africa's Treasury has rejected suggestions the economy could be heading for a recession, although there are signs it is feeling the strain of higher interest rates and slower global activity.
Retail sales in SA fell by an annual rate of 3,6% in May, their steepest fall in nine years, backing evidence that consumer spending has slowed sharply. The Organisation for Economic Co-operation and Development (OECD) released a statement recently in which it said that South Africa's economic growth rate still trails that of most dynamic emerging economies, with unemployment a key challenge to the country's development. It also noted that South Africa faces considerable inflationary pressures, including those from surging food and energy prices, which are expected to remain severe for some time. The inflation story is definitely not unique to SA and the Reserve Bank has consistently raised rates to try and control inflation and one wonders how far they intend to go without tipping SA into recession.
With the global economy in a sorry state and forecasts that things may yet get worse, emerging market economies will feel the pain of slowing investment and growing inflation. The rand remains prone to downside risks and the recent range between 15.00 and 15.50 looks likely to stay in place. Working orders at 15.50 may be the best way to seek value in the GBPZAR cross in the short-term but more ambitious rand buyers may want to hold fire for the moment and seek better exchange rates in
the medium term.
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