Rate cuts will undermine the South African rand’s health

COMMODITY currencies such as the Australian dollar and the New Zealand dollar have been in vogue over the past year as traders look to capitalise on rising commodity prices and take a punt on the global economic recovery. It is no surprise, therefore, that has added the US dollar-South African rand to its list of tradable currency pairs.

With the price of gold near historic highs and a football World Cup kicking off in less than three months time, South Africa is going to be in the news much more than usual, providing an excellent opportunity for foreign exchange traders to take a punt on the rand.

The South African rand has strengthened considerably, appreciating by 30 per cent against the US dollar over the past year. One of the reasons often cited for the rand’s rise has been the surging demand for gold as investors seek a safe haven in the precious metal. However, the price of gold is having less of an impact on the rand than it used to – the country has slipped from being the largest producer to third, usurped by China in 2007 and then again by Australia in 2009. But a strong rand has still made life difficult for South African exporters.

Still although some political factions have called on the government to devalue the rand to ease the pressure on companies, International Monetary Fund (IMF) president Dominique Strauss-Kahn said yesterday that such a move would be very short-sighted and would scare off the foreign investors and capital needed to fund the country’s current account deficit. But a devaluation might not be needed since a weakening of the rand against the dollar may be on the horizon anyway.

The World Cup is still expected to trigger a temporary improvement in the current account in the second quarter of this year thanks to travel receipts. Although the rand could temporarily benefit from the concentration of travel receipts, Citi analyst Jean-Francois Mercier points out that “these flows probably would not be large enough to prevent rand depreciation if a change in sentiment triggered meaningful capital outflows out of South Africa”.

Equally bearish for the rand in the second half of this year will be the pressure on the central bank to cut rates from the current level of 7 per cent. Bartosz Pawlowski, senior FX strategist at BNP Paribas, says: “Given the likely sluggishness of the economic recovery and the subdued picture for credit, the pressure for further rate cuts will intensify in the weeks and months ahead. Indeed, the inflation outlook will be consistent with an additional rate cut in the second half.”

This cut will put the South African rand under increasing pressure because it will be less attractive to speculative traders. Pawlowski says that there is potential for dollar-rand to extend the recovery trend that has developed since the beginning of 2010. His initial target for the pair is R8 but over the medium-term he warns that there is an increasing possibility of a break above this level towards the R8.20 area.

Whatever happens to the price of gold, going long on dollar-rand could prove a more profitable punt than betting on the World Cup.