The South African rand weakened early on Wednesday, as analysts expect that the Federal Reserve policy meeting later in the day could weaken it further. The rand had strengthened earlier this month when it rose against the greenback boosted by a weak dollar, Chinese policymakers’ promise to support their economy, and foreign buying of South African government bonds.
Economists linked the foreign bond-buying to a decline in South African inflation and a decision by the Reserve Bank last week to leave its main interest rate on hold. South Africa’s central bank kept rates unchanged last week after 10 consecutive hikes.
Rand Merchant Bank noted that following the rand’s recent gains, the South African currency was “stretched too far.” In regards to the Fed’s interest rate decision later on Wednesday, the bank said that “event risk is huge tonight” and that a sharp fall in the rand was a likely outcome.
South Africa’s rand dropped to the bottom of the G20 currency pairs on Wednesday and underperformed alongside the Chinese renminbi. Analysts anticipate that if the Fed’s language is hawkish later tonight, then the US dollar will strengthen, while emerging market currencies like the rand could weaken.
South Africa’s central bank keeps rates unchanged at 8.25%
The rand weakened after the central bank kept rates unchanged at 8.25% on Thursday, 20th of July, for the first time since November 2021. However, Governor Lesetja Kganyago clarified that the pause didn’t mean an end to the hiking cycle. Following improved economic conditions and lower inflation forecasts, the South African Reserve Bank’s (SARB) monetary policy committee (MPC) decided to keep rates at 8.25%. The governor noted that future rate decisions will depend on incoming data and potential risks to the inflation outlook. The SARB is expecting inflation to come in around 6.0% in 2023 and to fall back to the midpoint of the target range by the third quarter of 2025.
Fed to hike rates by 25 bps
The FOMC is forecast to announce a 25bp hike on Wednesday, and analysts believe it could be the last hike of the cycle. The next FOMC meeting will take place on the 20th of September, but with data showing that inflation is cooling, and economic growth has begun to slow down, the Fed may find it difficult to continue with another rate hike. With uncertainty about the Fed’s decision and heightened market risk, the rand may be sensitive. A lot will also depend on whether commentary from the FOMC is hawkish which could boost the greenback and weaken the rand.
The Fed would most likely increase the Fed Funds rate to 5.5% or surprise the markets by leaving it unchanged. US inflation is at 3%, close to the 2% average target, which is why the Fed could decide to leave interest rates unchanged this week.
Bank of Japan monetary policy decision
The Bank of Japan (BoJ) monetary policy decision could also have implications for the rand and could prove to be supportive if there is another change of the Yield Curve Control programme parameters to allow for higher government bond yields. On the other hand, a large increase could weaken other currencies. The Japanese yen has been positively correlated with many non-dollar currencies recently, but its negative interest rate, low bond yields and use as a funding currency for investments in higher-yielding assets could affect many other currencies if there is a large change of policy.