INFLATION could breach the upper end of its official target range by the year-end if the rand continues to depreciate, hitting consumers in their pockets and complicating the Reserve Bank’s interest rate decisions.
The currency has clawed back some of its losses but its slide to a three-year low of nearly R9 to the dollar this week puts it on course to push up the cost of food and fuel, which will fan inflation.
The rand also depreciated against the euro and the pound, taking a hammering from negative investor perceptions of South Africa prompted by a spate of wildcat strikes in the mining industry.
Analysts believe that after this week’s sharp plunge, the volatile currency will stabilise in a weaker range, which will nudge inflation closer to the top of its 3% to 6% target range.
But if the labour strikes which have also hit transport spread to other sectors of the economy, investor perceptions of South Africa will worsen, putting more pressure on the currency.
The gaping shortfall on South Africa’s deficit on the current account — its broadest measure of trade in goods and services — is also a threat to the rand, as the foreign portfolio inflows which have financed it so far this year have reversed.
If these factors conspire to push the rand beyond R9 to the dollar, inflation could breach its target range and the economy will be set for a painful bout of stagflation — which is a combination of sluggish growth, high unemployment, and rising inflation.
"Sentiment is very negative at the moment — there’s lots of instability in the economy and until things settle the rand is going to remain vulnerable," says Nedbank economist Isaac Matshego.
"We could see inflation getting closer to 6% if the rand stabilises at current levels. If it weakens further, going above R9 to the dollar, inflation could breach the target and remain outside of the band for most of next year."
A breach of the inflation target would normally force the Bank to consider raising interest rates, but this is out of the question in the face of a worsening global and domestic economic slowdown.
Nonetheless a pickup in inflation will make it very hard for the Bank to consider cutting interest rates again, after a surprise reduction in July. Local money markets are betting that there is more than a 50-50 chance of a rate cut by January next year.
The rand was trading at about R8.64 against the dollar late yesterday. Between May and September, the unit traded in a range between R8 and R8.50. Analysts say the rand is now likely to hover between R8.50 and R9 to the dollar for the rest of the year.
Investors will be looking towards the Treasury’s medium-term budget policy statement later this month for reassurance that fiscal discipline remains on track, which will help to support the currency. But the rand could also take a knock if the electoral conference of the African National Congress at the end of this year comes up with populist policies which would spook markets.
"A lot of bad news is already priced into the rand," says Absa Capital currency strategist Michael Keenan.
"It all hinges on how the strikes play out — clearly if they became more widespread the rand will weaken further to between R9.20 and R9.60 to the dollar," says Mr Keenan.
Econometrix Treasury Management MD George Glynos says the risks were tilted towards the rand weakening rather than strengthening. "That will tend to impact on inflation — between now and the end of the year a breach of the upper end of the target range is possible," he said.
The main conduits for higher inflation would be the rising cost of food and fuel, which together account for about 18% of the weight in the goods and services measured by the consumer price index.
If transport costs are included, the weight rises to about 25%.
Domestic petrol prices reflect the cost of importing fuel, which is denominated in dollars. Global grain prices are also dollar denominated, and affect local markets.
In its monetary policy statement last month, the Bank pointed out that the rand’s exchange rate was a "potential" risk to the inflation outlook, particularly if there was an unsustainable widening of the current account deficit.
The shortfall widened to 6.4% of gross domestic product in the second quarter of this year from 4.9% in the first quarter — its biggest in four years.
The worry is that the hefty foreign purchases of bonds which have financed the deficit so far this year will slacken — in the past 10 days there have been net sales of R6.1bn, according to JSE figures.
Source: BD Live
