Slowing inflation and the rand’s recovery this quarter have traders giving South African Reserve Bank Governor Gill Marcus better-than-even odds of emulating her peers in Europe and Australia in cutting interest rates.
Forward-rate agreements starting next February have dropped 29 basis points in the past month to 4.83 percent yesterday, or 30 basis points below the Johannesburg interbank agreed rate. The contracts are pricing in a 60 percent chance of a 50 basis-point rate cut in nine months, according to Standard Bank Group Ltd. Similar contracts in Turkey fell 12 basis points in the period, while those for the Czech Republic rose 27 basis points.
Rising unemployment and a slump in mining and manufacturing are putting pressure on Marcus to bolster an economy struggling to recover from lower commodity prices, waning demand for exports from Europe and labor unrest. The Reserve Bank of Australia cut its benchmark interest rate yesterday to a record, while European Central Bank President Mario Draghi said two days ago that further rate cuts are possible after reducing them to an all-time low last week.
“Rate cuts in key economies beyond our borders further strengthen the case for the Reserve Bank to ease policy,” Bruce Donald, a strategist at Standard Bank, South Africa’s biggest lender, said by phone from Johannesburg yesterday. “Our base case remains for a 50 basis-point cut by the first quarter of 2014, but the risks are increasing that such a move could occur earlier.”
The yield on one-year interest rate swaps, used to lock in borrowing costs during the period, fell 20 basis points over the past month to 4.94 percent yesterday. That’s one basis point off the lowest level in almost six months reached on May 5.
Marcus has left South Africa’s benchmark repo rate unchanged at 5 percent since a surprise cut of 50 basis points, or 0.5 percentage point, in July. The rand’s weakness and higher food and oil costs remain risks to consumer prices, and will probably push inflation above the central bank’s 3 percent to 6 percent target range temporarily, Marcus said April 19.
Since then, the rand has gained 2.2 percent, paring its decline this year to 6.1 percent. A stronger rand may help ease inflation by reducing the cost of imports, including crude oil. The currency appreciated 0.1 percent to 9.0194 per dollar at 4:30 p.m. in Johannesburg.
The yield difference between 10-year inflation-linked bonds and similar-maturity fixed-rate debt, an indication of investors’ expectations for average inflation over the period, has dropped 52 basis points to 5.55 percentage points since March 20, the date of the MPC’s last meeting. Inflation unexpectedly remained unchanged at 5.9 percent in March.
Commodities, led by gold and platinum, have declined 7 percent since reaching a four-month high in February, according to the Standard & Poor’s GSCI Index. The country is the world’s biggest platinum producer and metals make up more than half of its exports.
Lower interest rates may reduce the attraction of South African bonds, slowing capital inflows the nation needs to plug a current-account deficit currently at 6.5 percent of gross domestic product, close to the widest in four years. Foreign investors owned 38 percent of South African rand bonds at the end of April, according to Standard Bank, compared with 29 percent in 2011. Finance Minister Pravin Gordhan said last week he’s concerned about the effect it will have on the economy if the money leave when sentiment changes.
“This speaks to a difficult decision for the Reserve Bank,” Brigid Taylor, head of institutional flow sales at Nedbank Group Ltd. in Johannesburg, said in e-mailed comments yesterday. “Will a cut, in fact, spur growth, or will it deter foreign flows we desperately need?”
Yields on benchmark bonds due December 2026 were unchanged at 6.73 percent today. The yield fell to a record 6.64 percent on May 2.
Unemployment climbed to 25.2 percent in the first quarter from 24.9 percent, a government report showed this week. Mining output growth probably slowed to 4 percent in March from 7 percent, a separate report may show tomorrow. Mining and manufacturing make up about 20 percent of the economy, which is forecast to expand 2.6 percent this year after growing 2.5 percent in 2012, Gordhan said in February.
Australia’s central bank reduced its rate by a quarter of a percentage point to 2.75 percent, saying the Aussie’s record strength “is unusual given the decline in export prices and interest rates.” Draghi said in a speech in Rome the ECB is “ready to act again” after reducing the benchmark by a quarter point to 0.5 percent on May 2.
“The higher unemployment rate will feature in the May MPC statement and will be part of the reason the Reserve Bank will ensure that the policy rate remains low for long,” Carmen Nel, a Cape Town-based analyst at Rand Merchant Bank, said in e-mailed comments yesterday. “It is clear that easing pressure is mounting following the Reserve Bank of Australia’s rate cut.”