The South African Reserve Bank (SARB) held its MPC meeting around a week ago, during which it announced several important decisions that had already impacted the local currency market. The South African Rand continues the bullish move against the US dollar, as near-term prospects are pointing towards a bottoming interest rates cycle.

Rising inflation and faster-than-expected economic growth are putting increasing pressure on central banks around the world, which could transpire into a normalization of monetary policy, a development that could impact both the currency markets and other asset classes.

Repo rate unchanged

Based on the latest decisions, the SARB left the repo rate unchanged at 3.5%, after cutting it by 25 basis points at the previous meeting, on July 23rd. After reducing the rate by 300 bps since the start of the pandemic, the most important central bank in the African continent is showing early signs of a monetary policy shift, entering a period during which calibration will be a key challenge.
South African Rand and the US dollar

Financial risks have eased, as vaccination and the economic recovery continue. More important attention should be attributed to interest rates since that could have a significant impact on forex South Africa and other potential risks related to solvency or dampening effects on the economy.

Interest rates bottomed?

The SARB Quarterly Projection is currently pointing to a 25 bps increase in each of the 2nd and 4th quarter this year. This is a very important shift, suggesting the central bank had reached a bottom in interest rates during 2020 and now it is very like the rates will be biased to the upside.

Faced with these prospects, the South African Rand continued to rise against the US dollar. Since the USDZAR exchange rate is trading at 13.72 at the time of writing, that puts it at a level not seen since December 2019.

Flows are shifting towards higher yields and thus far there is no reason to believe the trend might reverse. A fast-paced appreciating currency could start to weigh on economic recovery, something that’s not what policymakers in South Africa want, considering the economy is expected to reach pre-pandemic levels in 2023.

Economic recovery and a potential third wave of the pandemic

There are already scenarios for a third COVID-19 wave in South Africa, as the weather got colder and people spend less time outside. Experts believe the country is unlikely to escape it since vaccination is still ongoing and much is needed until herd immunity is reached.

Household spending is expected to be healthy in 2021, fixed investments stabilizing, and a 2.7% GDP growth during Q1 are encouraging developments in the country, yet a third wave of the pandemic could completely change the picture.

Regardless of the outcome, South Africa continues to be a country with strong economic prospects, and the South African Rand one of the trending emerging markets currencies. Unfortunately, the pandemic can still have a major impact on how things progress moving forward since the virus can continue to mutate.