It’s Rand Versus Rates Traders on Policy: South Africa Credit

Investors in the rand are taking South African central bank Governor Lesetja Kganyago at his word that inflation hasn’t fallen enough to justify interest-rate cuts. Derivatives traders hold the opposite view.

The rand gained as much as 1.1 percent against the dollar after the Monetary Policy Committee unanimously decided to leave the repurchase rate unchanged at 5.75 percent on Thursday, and Kganyago said the bar for it to drop is “high.” At the same time, forward-rate agreements, used to speculate on borrowing costs, showed 20 basis points of cuts through September, and yields on government rand bonds due December 2026 fell to the lowest since May 2013.

While the Reserve Bank reduced its forecast for average inflation this year to 3.8 percent, from 5.3 percent two months ago, Kganyago said the outlook for the oil price and exchange rate remained unclear. Policy makers also cut their 2015 growth forecast as power blackouts crimp production.

“There is a bit of second-guessing in the market about whether or not the Reserve Bank has done enough” to stoke growth, Jeffrey Schultz, an economist at BNP Paribas Cadiz Securities in Johannesburg, said by phone on Thursday. “The big wild card is what happens with the global oil price.”

The central bank raised the key rate by 75 basis points last year, and prior to the plunge in oil prices had indicated it would rise further. The price of crude has slumped more than 50 percent since June.

High Bar

“We are in the process of interest-rate normalization,” Kganyago told reporters in the capital, Pretoria. “The lower inflation path gives us some room to pause in this process, particularly against the backdrop of a continued weakness in the economy. The MPC is aware that the moderation in inflation could raise expectations of lower interest rates.”

Consumer-price inflation has been within the central bank’s 3 percent to 6 percent target since September. The bank forecasts the average rate will rebound to 5.1 percent next year.

“The bar of further accommodation remains high and would require a sustained decline in the inflation rate and inflation expectations,” Kganyago said.

The difference in yield between five-year fixed-rate bonds and index-linked debt, a measure of investor inflation expectations over the period known as the break-even rate, fell 14 basis points on Thursday to 4.93 percentage points. That’s the lowest since Bloomberg started compiling the data in May 2012.

“The bank is doing exactly the right thing,” Nazmeera Moola, an economist and strategist at Investec Asset Management, said by phone from Cape Town. “They are viewing this fall in inflation as temporary so they are looking through the plunge in the oil prices. They’re aiming for stability and the way to get stability is to not take any short-term benefits which would quickly be reversed.”

The rand traded at 11.5195 per dollar by 6 p.m. on Thursday in Johannesburg, 0.5 percent stronger for the day. Yields on government rand bonds due December 2026 fell seven basis points to 7.04 percent.

“The fact that Mr. Kganyago is even talking about the possibility of looser monetary policy speaks volumes about the changed inflation landscape,” Nicholas Spiro, managing director of Spiro Sovereign Strategy, said in an e-mailed response to questions. “The lack of growth is the overriding concern for South African policymakers, and has been for quite some time.”

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