There is a chance that the Reserve Bank will cut interest rates in the first quarter of this year, but the move would not curb gains in the rand, which are being driven by global forces, analysts say.

The volatile unit briefly firmed one percent to R7.27/ yesterday, backing concern it may break below the key R7/ level early this year — a development that may hamper South Africa's economic recovery.

It retreated to R7.36/ later in the day.

Local markets are betting there is virtually no chance that the Bank will ease monetary policy any further after lowering its key repo rate by a total of five percentage points to seven percent last year.

But some analysts put the odds of a further reduction as high as 35 percent, given that a stronger currency improves the inflation outlook by making imports cheaper.

Rand gains erode competitiveness

"We still hold the view that the odds of an additional rate cut are higher than what the FRA (forward rate agreement) curve is currently pricing in," said Citigroup economist Jean Francois Mercier. "Nevertheless, we still see this probability as less than 50 percent," he said in a research note yesterday.

Gains in the rand erode the competitiveness of local exports, which have already been hit by the global and domestic downturn. The unit was the world’s second-best performer versus the dollar last year, and hit a two-year peak against the euro last week.

In the past, the "carry trade" appeal of higher interest rates has been seen as a factor behind gains in emerging market currencies. But strength in the rand now stems mainly from foreign buying of local equities — which reached a record R76-billion last year.

Rising commodity prices have also been a driver of rand gains, with prices for platinum, SA's main export, scaling a fresh 16-month peak at $1590.50/oz yesterday.

Concern over rand's gains

Finance Minister Pravin Gordhan added his voice last year to spreading concern over the possible effect of the rand's gains on SA's recovery. But he and Bank governor Gill Marcus have repeatedly said that SA should stick to its policy of letting markets determine its level.

Analysts say cutting interest rates will have little effect on the rand, and could even prove counterproductive if it prompts foreign buying of interest rate sensitive stocks.

"Our view is they will keep rates on hold for a longer period of time, but we can't say there is no chance of a cut," said Stanlib economist Kevin Lings.

He puts the odds at 65-35. The Bank's first monetary policy meeting this year takes place in two weeks.

The "window of opportunity to trim rates is likely to close in the second half of this year, when the rand is set to depreciate", said Rand Merchant Bank economist Carmen Nel.

"A rate cut is unlikely to impact on rand strength because it is not being driven by the carry trade — it is being fuelled by strong commodity prices and equity inflows," she said.

Article by: John Loos and Ewald Kellerman - www.iafrica.com