The rand’s slide to the lowest since 2001 isn’t proving to be as big a headache for South African policy makers as it was the last time the currency was in free-fall.
Two years ago, the South African Reserve Bank estimated that every 10 percent decline in the rand boosts the inflation rate by 2 percentage points. While the bank still cites the rand as the main risk to inflation, it now estimates the pass-through effect of a weakening currency to consumer prices may be about half of what it initially assumed. Inflation-linked bonds suggest investors aren’t so worried either, as the rand heads toward 13 to the dollar.
The rand’s more muted effect on prices, mainly due to weak demand in the economy and increased competition among retailers, is benefiting the inflation outlook at the same time that oil prices trade near a six-year low of $50 a barrel. That gives Reserve Bank Governor Lesetja Kganyago scope to limit rate increases in an effort to support an economy hit by power shortages, falling commodity prices and strikes.
“We’ve had petrol-price shocks and food-price shocks and a huge exchange-rate shock, but core inflation actually behaved itself quite well,” Dave Mohr, the chief investment strategist at Cape Town-based Old Mutual Wealth, said by phone Aug. 14. “That shows that the economy is less inflationary than what traditional models show.”
Core inflation, which excludes a broad group of food and energy costs, eased to 5.4 percent in July, the lowest in 17 months, the statistics office said on Wednesday. Headline inflation accelerated to 5 percent from 4.7 percent, in line with the median estimate of 25 economists surveyed by Bloomberg.
The five-year breakeven rate, a measure of bond investors’ inflation expectations in the period, fell five basis points this month to 6.53 percent even as the rand slid 2 percent against the dollar. That compares with a 20 basis-point increase in the same period in Turkey, one of South Africa’s emerging market peers.
Investor expectations of another interest-rate increase have barely budged this year despite the currency’s weakness. Forward-rate agreements starting in five months, used to speculate on borrowing costs, show traders are pricing in 34 basis points of interest-rate increases by the end of the year, compared with 38 basis points at the beginning of the month.
The central bank raised its benchmark repurchase rate on July 23 for the first time in a year to 6 percent as it forecast inflation will exceed the 3 percent to 6 percent target band for the first half of next year. The bank’s current interest-rate tightening cycle will be “moderate,” Kganyago said on Aug. 11.
“Oil is coming down and inflation forecasts will probably be revised downwards a bit on the basis of that,” Jonathan Myerson, head of fixed-income investments at Cadiz Asset Management Ltd. in Cape Town, said by phone on Aug. 14. There’s a chance of another interest-rate increase this year as the U.S. Federal Reserve moves closer to tightening monetary policy, he said.
The rand weakened less than 0.2 percent to trade at 12.9357 per dollar as of 4:50 p.m. in Johannesburg on Wednesday, taking its decline since the start of the year to 10.6 percent. Yields on rand-denominated government bonds due December 2026 gained three basis points to 8.31 percent.
“The rand’s weakness will not necessarily lead to an inflation problem,” Elize Kruger, an economist at KADD Capital, said by phone from Johannesburg on Aug. 17. “It is a risk, but it’s not a risk that has played out to the same extent as it did in the past after rand weakness.”