South African prices rose at their fastest pace in 17 months in July, driven by higher food costs, but markets mindful of a worsening global economic outlook continued to factor in more monetary stimulus via a possible interest rate cut.
Central bank governor Gill Marcus put investors on alert on Tuesday for the chance of a cut, saying domestic growth likely slowed in the second quarter and the bank would act “appropriately” in the event of a marked global slump.
Local bond yields fell to record lows after Marcus' comments before bouncing back, with some saying the market was running ahead of itself on rate cut hopes. But they edged down again after Wednesday's CPI figures, with the 2015 yield dipping to 6.52 percent from 6.55 percent.
Annual consumer price inflation rose to 5.3 percent in July from 5.0 percent in June, the data from Statistics South Africa showed - its highest since February 2010 when it fell inside the Reserve Bank's target of between 3 and 6 percent.
The central bank had previously said it saw inflation peaking outside its target range at 6.3 percent in the first quarter of next year, and Marcus said Tuesday the outlook for inflation was “benign” when stripping out administered prices.
The bank has held its repo rate at 5.5 percent this year after cutting it by 650 basis points to a three-decade low in the two years to end-2010.
TO CUT OR NOT TO CUT
Despite cheaper borrowing, consumer spending has not recovered and the manufacturing sector also remains sluggish, backing the case for more monetary stimulus.
But market players were divided over whether Wednesday's figures meant more rate reductions were on the cards.
“I think (this CPI number) is not going to make any difference to the calls growing in the market for a rate cut,” said Colen Garrow, economist at Brait.
“I think it is going to be a question of timing and I think it's probably going to be, I hope, sooner rather than later because the winds of contagion coming around have nothing to do with inflation.”
The forward rate agreement (FRA) market has priced in a 40 percent chance of a rate cut as early as the next meeting on September 20-22. The rate on the 1x4 contract was at 5.41 percent.
But Razia Khan, head of Africa research at Standard Chartered Bank, said that did not necessarily mean a near-term easing was likely.
“Although the FRAs have started to price in some likelihood of a rate cut, we believe the (central bank) will want to play things more cautiously for now - only acting in the event of an undisputed renewed growth shock,” Khan said.
South Africa's prospects are closely linked to those of the developed world, especially the euro zone where fallout from a debt crisis has slowed growth.
Local GDP figures for the second quarter will be released next Tuesday and economists expect growth to have slowed from the first quarter's 4.8 percent.
But the bank “will require more than a soft Q2 domestic number before cutting,” said Peter Attard Montalto, emerging market analyst at Nomura.
He said the bank would be loath to cut rates in an environment where the rand had potential to depreciate and when wage demands have been so far above inflation
“That means rates on hold for September and November. If rate cuts do happen they will be in Q1 at the very earliest - though ...I do not think that will happen either as my baseline.”
A resilient rand has helped keep inflation inside the central bank target, though the currency has come under pressure in recent weeks due to heightened risk aversion. It hit a one-year low of 7.50 two weeks ago and was last at 7.21 to the dollar.
Recent wage settlements have also been above the inflation rate, with workers in some sectors demanding double-digit increases. - Reuters