There is widespread agreement that interest rates have peaked, but the rand's stability in the face of severe global turbulence remains key to the timing of the first cut in local lending rates.

Reserve Bank Governor Tito Mboweni highlighted the rand's depreciation as a "significant upside risk to the inflation outlook" when he announced the Bank's decision to keep interest rates steady yesterday.

He warned that the latest slide in the currency, which briefly hit a near seven-year low at R9.45 to the dollar this week, offset the benign impact of lower oil prices on petrol costs — one of the main drivers of record inflation.

Exchange rate impact

"The impact of the exchange rate on the inflation outlook will depend to a significant degree on the extent to which these new levels are sustained," Mboweni said in a televised statement.

The rand was trading at R9.03/1 late yesterday, after briefly firming to R8.95/1 once the Bank's policy meeting ended.

Its decision to keep the repo rate at 12 percent was anticipated, but there was some disappointment that SA had not followed many of its global counterparts with a rate cut in the face of financial turmoil.

"Essentially, rather than talking about how bad the crisis is for growth, the Bank spoke a lot about how rand weakness was bad for inflation," said Absa Capital interest rate strategist Nyiko Mageza.

Hawkish statement

"They also said they didn't discuss a rate cut at all at the meeting — it was kind of a hawkish statement, especially for those speculating on a cut."

Government bonds weakened after the news, with yields on the R153 bond, maturing in 2010, up by seven-basis-points at 9.29 percent. Yields on the benchmark R157 bond, due in 2015, rose by four-basis-points to 8.87 percent.

Forward rate agreements on local money markets also responded, pricing in a greater chance of a rate cut in February next year instead of December this year, as was previously the case. Most analysts think rate cut optimism is still overdone.

"The question now is not if interest rates are going to fall, but when, and that will be determined by the currency," said Efficient Research chief economist Dawie Roodt. "I doubt the Bank will increase interest rates unless the currency bombs out completely. But if the rand stays weak, we won't see a cut until June."

Roodt's base case scenario is for the rand to strengthen back towards R8/1, spurring an expected fall in inflation next year and prompting rate cuts this December or in February next year.

He is betting that SA's interest rate differential with the rest of the world will appeal to global investors, once the dust of the financial crisis settles.

When that will happen is anyone's guess. But technical analysts say the rand is most likely to depreciate further.

"Prospects of a weaker rand and imported inflation coming through will limit the scope for rate cuts," BoE Private Clients analyst Gregor Krall said.

Bearish rand breaks

"What is key is the bearish rand breaks against the euro and the pound. I think the amount of the rate cuts we are expecting may be in question."

Markets are pricing in three percentage points of cuts from early next year, after a cumulative increase of five percentage points since June 2006.

Krall predicts that over the next three to 12 months the rand will weaken to above R10/1, R14 to the euro and R17.5 to the pound. That may seem a bit grim as the currency is trading at R12.3 to the euro now and R15.5 to the pound.

But less than two weeks ago, he forecast the rand would hit R9/1, while it was still at R8.27/1. He said that was triggered by breaks of key levels at R12.15 to the euro and R15.20 to the pound.

Technical analysts base their predictions on history rather than "fundamentals" like growth, inflation or trade deficits, which might be a good approach to take.

"The interest rate outlook is more uncertain than usual, given the global credit crisis and the resulting FX and local asset volatility," said Citigroup economist Jean-Francois Mercier. "We remain of the view that rates are on hold for a while and unlikely to decline until June next year."

"Prospects of a weaker rand and imported inflation coming through will limit the scope for rate cuts."

Business Day