South African Rand: 1-3 Month Outlook

SARB opted to hike its key reference rate by 25bp to 6% on July 23.  

The market is pricing at least one more hike before the end of 2015. While we do believe USD/ZAR may drift higher towards 12.90 in the very near term and perhaps even break 13. We agree with SARB's assessment that the rand is quite undervalued. The rate hike therefore signals that additional currency weakness may raise inflation. 

"This combination of a hawkish central bank with a controlled and gradual increase in headline inflation may trigger ZAR outperformance against other floating EM currencies. We estimate that headline inflation may remain below 5% y/y until September. An increase in the headline above 5.5-6% between January and December will likely push SARB to hike again in the 17-19 November meeting. This should be compounded by the beginning of the Fed tightening cycle in the September FOMC", says RBC Capital Markets. 

Domestic demand might be slowing somewhat as a result of job market deterioration. The trade balance finally seems to have shown a more meaningful improvement since bottoming in February. Still, a dip in metal prices poses a severe concern to external accounts going forward. This might be partially compensated by lower energy prices.