Johannesburg - The rand's movements will probably be the key to South Africa's economy in 2011, Riaan le Roux chief economist at Old Mutual Investment Group SA (Omigsa) said on Tuesday.
Le Roux was speaking at Omigsa's quarterly briefing.
Although he expected improved economic growth of about 3.5% for the year ahead, assisted by gradual rand weakening, he said the unit's moves would determine whether interest rates and inflation remained low to help keep the economy on a positive growth path.
"As we know, the currency is probably the most 'unforcastable' factor in our economy.
"In 2010 the rand was the third strongest major currency in the world ... This kept our inflation in check, allowed interest rates to fall to 35-year lows and consequently helped boost consumers' incomes after a tough 2008-2009," he said.
Le Roux said this could unravel in 2011 but that was not likely.
"However, we do believe the rand is overvalued at its current levels."
Some of the factors that made the rand attractive to offshore investors last year were becoming less so, he said.
"For example, rising inflation in certain emerging markets is causing them to raise their interest rates, making SA's interest rates relatively less attractive, especially since we expect our rates to remain largely unchanged for the year."
Le Roux said that emerging market growth could also slow relative to developed markets as higher interest rates acted as a drag on the former, while the latter continued to enjoy easy money and economic growth accelerated.
"This means investment conditions are now somewhat less favourable for emerging markets in 2011 than they were in 2010.
"At one end of the scale, China's inflation and any consequent policy tightening will be keenly watched for their negative impact on growth.
"At the other end, we're already seeing stronger-than-expected growth data in the US, which could turn out to be the global surprise of 2011 and help swing investor sentiment back towards developed markets."
This, he said, could contribute towards rand weakness.
Le Roux added that a sharp rand depreciation would be a threat to SA's economy as it would set off inflationary pressures - especially with rising oil and food prices.
"While the speed and extent of any rand weakening is hard to predict, some softening would be welcome as a spur to economic growth."
Le Roux expected an exchange rate of R7.50/$ by the end of the year.
Assuming a moderate rand depreciation, a moderate rise in food prices and oil at $95 per barrel, consumer price inflation should remain within the Reserve Banks' 3% to 6% target band, but increase gradually to end the year at around 5%.
"This means interest rates are likely to remain around their current low levels for most of the year with the first rate hike seen only during the fourth quarter of 2011 at the earliest."
Le Roux said such a scenario would be positive for the country's economic recovery, helping to lift growth to about 3.5% in 2011.