April 10, 2017 / 5:00 PM / 9 months ago

UPDATE 2-South African central bank says downgrades, weakening rand pose risk

* Rand has weakened nearly 12 percent since March 27

* S&P, Fitch have downgraded South African credit to junk

* Bank says will not intervene directly to support rand

* Bank says too early to say if downgrades will cause recession (Adds governor’s comments on recession)

By Mfuneko Toyana

PRETORIA, April 10 (Reuters) - South Africa’s central bank on Monday warned that a recent cabinet reshuffle that saw the finance minister fired and the country’s credit rating relegated to “junk” could put pressure the rand and accelerate inflation as inventors sold off local assets.

The rand has dropped nearly 12 percent since March 27, when President Jacob Zuma recalled then-finance minister Pravin Gordhan from an international roadshow, then fired him later that week.

In response, S&P Global Ratings and Fitch cut the country’s sovereign credit rating to sub-investment grade, both saying Gordhan’s departure raised the risk of a fiscal policy shift.

The central bank governor said it was too early to tell whether the downgrades would push the economy in to a recession.

“It’s too early to tell if we are in a recession,” South African Reserve Bank (SARB) Governor Lesetja Kganyago said at the release of the regulator’s Monetary Policy Review.

“The environment is pretty fluid ... With the downgrades, we expect the cost of capital to rise, and that rising cost of capital could force businesses that wanted to invest to rethink some of their projects. That will have an impact on growth.”

In March, the bank kept its benchmark repo rate unchanged at 7 percent, citing re-emerging risks to the exchange rate. It added then that it had reached the end of its tightening cycle, which has seen it raise rates a total of 200 basis points since 2014.

“Domestically the situation has been challenging ... it has been making policy-making very difficult,” Kganyago told a news conference after the bank released its Monetary Policy Review.

The bank said in its review, released twice a year, that the biggest risk to its policy aim of keeping consumer prices below 6 percent was the weakening exchange rate.

“Rising uncertainty about the future of economic policy could prompt capital outflows in anticipation of such downgrades,” the bank said in the report.

“The risk is that the rand could follow a more depreciated path than expected, which would, other things being equal, raise inflation,” the bank said in the statement.

Before that meeting, forward rate agreements were pricing in at least one rate cut by 25 basis points in 2017, but on Monday the forward markets were pricing zero percent probability of a cut this year .

In response to questions from Reuters on Monday, the bank said it would stick to setting benchmark lending rates rather than intervene in the exchange markets.

“We would consider becoming involved if the orderly functioning of the foreign exchange markets is under threat, guided by financial stability considerations,” Deputy Governor of the Reserve Bank (SARB) Daniel Mminele said in emailed responses to questions. (Editing by James Macharia, editing by Larry King)

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