Rand stronger for longer

MONETARY policy in the US and Britain has remained very loose, probably for longer than people thought possible. The European Central Bank (ECB) has started raising rates, but is taking baby steps.

What does all this mean for the rand and investment in SA?

In the US, markets sat up and took notice when US Federal Reserve chairperson Ben Bernanke appeared to be hinting at another round of quantitative easing in testimony last month to the House of Representatives' financial services committee.

Quantitative easing is another form of easing monetary policy from cutting interest rates. It's implemented when the central bank has cut interest rates to zero, but the banks have failed to respond with enough lending.

Quantitative easing floods the banking system with liquidity, so that banks have all this surplus cash that they then want to lend out. The way it works is that the Fed buys US treasury bonds.

Through buying the bonds, the Fed is also putting downward pressure on long-term interest rates, which keeps US home loan rates low. In the US, home loan rates are linked to long-term rates in the government bond market.

The US Fed has spent more than $2 trillion on quantitative easing in two rounds. The second round, known as QE2, gave rise to a lot of criticism because there were fears that this rapid expansion of the money supply would ignite inflation. But that hasn't been the case, and the Fed chief's judgement appeared to be spot on.

The US economy has been going through what some have termed a soft patch and what others fear may be the first signs of a double-dip recession.

In the second quarter of this year, US gross domestic product rose by only 1.3% quarter-on-quarter, annualised from a heavily revised tiny growth rate of 0.4% in the first quarter. The growth performance in the second quarter was well below market expectations for growth of 1.8%.

Stronger euro should boost rand

Though Bernanke's comments were made before those figures were out, high frequency data meant the writing had already been on the wall. The US economy is weak. That's why Bernanke caused some excitement when he said last month: "The possibility remains that the recent economic weakness may prove more  persistent  than expected and that deflationary risks might re-emerge, implying a need for additional policy support."

But after much excitement, Bernanke soon afterwards said now was not the time to launch a new round of stimulus. "We are not prepared at this point to take further action," Bernanke told the senate banking committee.

Still, the fact that QE3 still remains a remote possibility says a lot about US monetary policy. It means the Fed will delay withdrawing liquidity from the market. Although QE2 finished at the end of June, the Fed won't withdraw the cash pumped in through the exercise, which would be a tightening of policy.

As for interest rates, it might be a long time before the Fed fund's target rate goes up from its present 0% to 0.25%. That may only happen by the middle of next year, or even later.

When it does, money will flow into dollars again and the rand will weaken. But in the meantime, barring any eurozone crises, expect the rand to stay relatively strong because of low US interest rates.

The ECB raised interest rates last month for the second time this year and signalled further policy tightening ahead to tackle inlfation, despite the debt crisis in the eurozone. But rates are still very low at 1.5%.

The ECB has to be careful not to rush things on the interest rate front, because European banks with large exposure to nations in crisis could be very hard hit if rates rise too fast. Expect one more interest rate hike this year of 0.25 basis points in the last quarter of this year.

The ECB's interest rate hikes should make for a stronger euro, which has been battered by the debt crisis. That, in turn, should also be positive for the rand.

In Britain, the Bank of England has stood firm by holding borrowing costs at the emergency level of 0.5% seen since early 2009 despite inflation, at more than 4%, being more than double its targeted level.

Perhaps here's a lesson for SA – that a kneejerk reaction to above-target inflation isn't necessary when the economy is shaky. But bear in mind that the UK economy is very weak and that fiscal policy is very tight.

The bottom line for SA is that monetary policy in some of the advanced economies is positive for risky trades such as SA. Barring another debt crisis, the rand will remain stronger for longer.

 - Fin24  

We live in a world where facts and fiction get blurred
In times of uncertainty you need journalism you can trust. For only R75 per month, you have access to a world of in-depth analyses, investigative journalism, top opinions and a range of features. Journalism strengthens democracy. Invest in the future today.
Subscribe to News24
Brent Crude
All Share
Top 40
Financial 15
Industrial 25
Resource 10
All JSE data delayed by at least 15 minutes morningstar logo
Company Snapshot
Voting Booth
Please select an option Oops! Something went wrong, please try again later.
Yes, and I've gotten it.
21% - 1039 votes
No, I did not.
52% - 2594 votes
My landlord refused
28% - 1400 votes