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Despite weak growth and a stronger exchange rate, South Africa's inflation has eased only slightly since its high of 7 percent in February. Inflation remains above South Africa's Reserve Bank's (SARB) target, stoked by high food prices due to the drought.
In efforts to curb stubborn inflation, the SARB has raised interest rate. After lifting the key interest rate by 50 basis points in 2015, two further steps of a further 75 basis points in total followed in Q1 2016. Since then, the key interest rate has been a stable 7 percent.
The SARB remains inclined to stem inflation. It sent out a clear signal that despite weaker economic growth, controlling inflation is the priority. SARB expects headline inflation to return to the target band in Q2 2017.
SARB is likely to maintain a tightening bias. But real interest rates are still relatively low compared to other EMs. Rather unattractive real interest rates and weak external balances combined with possible rating downgrades constitute a difficult environment for the rand.
"We therefore see the risk of ZAR depreciating against USD again in the coming months. Towards the end of 2017, we expect USD-ZAR levels of around 15.50." said Commerzbank in a report.
