Most analysts did not expect any change to the repo rate at the September meeting of the Monetary Policy Committee (MPC) of the Reserve Bank. At the announcement of the result of the meeting the Governor kept the analysts on the edge of their seats, before letting them down gently and leaving the repo rate unchanged at 7%. Globally the growth forecasts have kept improving and this is expected to spill over into South Africa. As a result the general expectation is that the repo rate has reached its bottom at 7%.

The CPI number that came out at 6.4% during the month was in line with expectations. This was down from the previous month's 6.7%. PPI came out lower than expected at - 4% versus the expected -3.5%, and down from the previous month's -3.8%. The Reserve Bank expects CPI to move into the target range by the 2nd quarter of next year and then remain there for an extended period of time.

The rate of growth in credit extension has continued to slow declining to 2.3%; down from the previous month's 3.4% and lower than the market's expectation of 2.75%. Money supply, as represented by M3, has also continued slowing, growing at a rate of 5.5% versus last month's 5.7%. These figures are indicative of an economy that is ticking over at a very slow pace and we will need to see a reversal of this trend before we can say that we have bottomed out.

The Rand has continued strengthening against the US$, moving from R$7.79 to R$7.60 over the month. As the oil price also weakened slightly over the month, we can expect a reduction in the petrol price in October. There has also been a further improvement in the global risk appetite, as illustrated by the reduction in the Emerging Market Bond Index spread from 382 basis points (bps) to 327 bps over the month. South Africa has also benefited from this with its sovereign spread improving from 224 to 193 bps. It was a marginally positive month for the bond market, with the small rise in rates being negated by the running yield of bonds. The market benchmark All Bond Index had a positive return of 0.08% over the period. The R157 government bond maturing in 2015 rose by 11 bps to 8.29% and the R186 maturing in 2026 rose by 10 bps to 8.865%.

The money market rates were somewhat mixed this past month. The three-month NCD rate declined by 15 bps to 6.9% and the 12-month NCD rate increased by 18 bps to 8.08%, in line with the increase in the bond rates. The money market benchmark STeFI composite had a return of 0.62% over the month.

While there does remain some risk that the repo rate could decline further, we believe it is fairly small. We believe that the repo rate is likely to remain at the current level well into next year. As the yield curve is fairly positive, one is being compensated for the risk of investing at the longer end of the yield curve. We will therefore continue doing so until we see an improvement in economic activity.

The world economy is showing signs of having bottomed out and there are some early signs that the environment is improving, but it is likely to be a slow process. While South Africa is officially in recession we are seeing a few green shoots - we have recorded our first trade surplus since December 2006 and car sales for June have shown their first consecutive monthly gain since 2007.

The Monetary Policy Committee (MPC) of the Reserve Bank surprised the market by not cutting the repo rate at their June meeting. The market had been expecting a further 50 basis point cut. Notwithstanding a very weak economy, the MPC expressed concerns over a stubbornly high consumer inflation rate that was being fed by costpush factors. With the oil price continuing its upward trend the likelihood of further petrol price increases remains high, notwithstanding the Rand having strengthened over the same period. This past week's announcement by the National Energy Regulator of a 31.3% increase in the price of electricity will add further fuel to this fire.

What has been concerning is the gap that has emerged between the CPI and PPI numbers. While CPI came down over the month from 8.4% to 8%, it was higher than the expected 7.9%. PPI on the other hand came down from 2.9% to -3.0%, even lower than the expected -1.8%. PPI is now in deflation! This widening gap could be the reason the Competition Commission recently launched an investigation against the supermarket chains.

A further indicator of the weakness in the economy is the continued decline in private sector credit extension, from 8.5% to 5.7%, lower than the expected 8%. Money supply growth (M3) also declined further from 8.5% to 7.3%. This ongoing weakness would have been the reason for the market having expected a further cut in the repo rate. The global risk appetite has continued to improve as reflected in an ongoing reduction in the emerging market bond spread that declined from 446 to 424 basis points (bps) over the month. SA also benefitted, with its sovereign spread improving from 311 to 286 bps. The US 10 year government bond rate improved by 8 bps to 3.54% over the month.

In his budget vote speech to Parliament the new Minister of Finance, Pravin Gordhan, advised that government revenues were likely to be up to R60 billion lower than originally budgeted. This had the immediate effect of pushing bond market rates higher. The bond market benchmark All Bond Index had a negative return of 0.19% over the month.

As the market had been expecting a cut in the repo rate, money market rates rose sharply after the MPC meeting announcement. The three-month NCD rate rose by 40 bps to 7.50% and the 12-month NCD rate rose by 72 bps to 8.30%. The money market benchmark Stefi composite had a return of 0.70% over the month. The expectation of further cuts in the repo rate had been predicated on the view that the MPC would want to further stimulate the very depressed economy. As it turned out, the MPC has reaffirmed that its primary objective is managing the inflation rate. For this the Reserve Bank should receive a lot of credit, particularly if one considers the political pressure they have been under. The new government has also come out in support of the inflation targeting regime.

Market expectations are for the repo rate to remain at the current level of 7.5% for an extended period of time, after which it could start drifting up. Should the economy fail to recover, and the CPI rate moves closer to the PPI rate, the risk is that we could see further cuts in the repo rate. Our base case, however, is line with market expectations.

As mentioned above, money market rates have moved up sharply. As a result longer term money market assets are very attractively priced relative to what they were a month ago. The risk, however, is that these rates could rise further, resulting in capital losses. With the next move in interest rates expected to be up, albeit only quite some time away, we are currently favouring the shorter end of the money market yield curve.

Just as speculation of an intra-meeting repo rate cut died down, the Monetary Policy Committee (MPC) of the Reserve Bank surprised the market by announcing a revision to its 2009 meeting schedule to allow for monthly MPC meetings (except in June) instead of bi-monthly meetings. In line with expectations, at their meeting on 24 March, the MPC announced a cut in the repo rate of 100 basis points (bps). This followed cuts of 100 bps in February and 50 bps in December. The Reserve Bank indicated that while its near-term inflation outlook had deteriorated since its February meeting, its medium-term outlook (which is more relevant for the policy decision) had improved.

The inflation numbers released during this month showed a mixed picture, with consumer inflation rising and producer inflation falling. CPI came out at 8.6%, up from the previous month's 8.1% and higher than the expected 8.2%. PPI on the other hand came out at 7.3%, down from the previous month's 9.2% and slightly lower than the expected 7.4%. CPI was negatively impacted upon by higher medical costs and a hike in the petrol price. PPI benefitted from ongoing disinflation of food and other commodities in line with their international counterparts. The expectation is that this will eventually feed through into consumer goods prices, especially given the weak state of domestic activity. But consumer food inflation has remained very sticky and needs to be carefully monitored.

As further evidence of a slowing economy, money supply (M3) continued its declining path from 13.92% to 13.17% and private sector credit extension declined from 11.85% to 11.05%.

The Rand strengthened over the month from R$10.26 to R$9.66, but the price of oil increased slightly from US$44.06 to US$46.74. The South African sovereign spread moved out slightly from 424 to 426 bps over the month. The Emerging Market bond spread on the other hand declined from 649 to 636 bps, possibly giving the first sign of a turnaround in the global risk aversion trades. The US 10 year government bond rate declined by 30 bps over the month from 2.99% to 2.69% as the Federal Reserve started buying back government bonds. The objective here is to pump more money into the financial system thereby easing the tight liquidity situation in the system.

The bond market was fairly neutral over the month with the All Bond Index having a return of 0.06%. The short end of the curve had a good positive return feeding off the decline in the repo rate, while the long end of the curve had a negative return on the back of the weaker than expected CPI numbers.

The R153 government bond maturing in 2010 declined by 5 bps over the month to 6.89%, the R157 maturing in 2015 increased by 10 bps to 8.17% and the R186 maturing in 2026 increased by 16 bps to 8.67%.

Short term money market rates declined meaningfully over the month in line with the 100 bps cut in the repo rate. The three-month NCD rate declined by 90 bps to 8.75% and the 12-month NCD rate declined by only 15 bps to 8.30%.

The Reserve Bank is expected to continue with its rate cutting over the next few months. There is a fair amount of uncertainty around the timing and extent of the cuts as the most recent CPI numbers have disappointed and the Reserve Bank has warned that the market should not expect that while there will be more frequent MPC meetings, that there will be a cut at each meeting.

The money market yield curve has flattened meaningfully over the past few months with the current levels indicating that the repo rate is unlikely to fall as far as previously expected. We will nevertheless remain fairly fully invested as call rates are still expected to continue declining.

In line with expectations, in December the Monetary Policy Committee (MPC) meeting of the Reserve Bank cut the repo rate by 50 basis points (bps) to 11.5%. This was the first cut in the official interest rates since the start of the 5% interest rate hiking cycle that began in June 2006. The prime motivation for the cut was the improvement in the inflation outlook since the previous meeting of the MPC. The oil price has declined significantly, coming down to US$37.66 at the end of December from a high of US$145 during July 2008. The trend in international food prices has followed that of other commodities and was working its way into lower local food prices. The MPC was now seeing inflation getting back below the upper level of the inflation target of 6% by the third quarter of 2009. The decline in the exchange rate from a high level of R$7.21 in August to a low of R$11.57 in October remains as a risk to the inflation rate. The Rand has, however, recovered quite considerably from the weakest levels to R$9.47 at the end of December.

The inflation numbers that came out during the month would have given further support to lower interest rates. The CPIX came out at 12.1%, down from the previous month's 12.4% and only slightly higher than the expected 11.9%. The PPI came out at 12.6%, much lower than the previous month's 14.5% and the expected 13.7%.

The growth outlook for South Africa remains very weak going into 2009, with household consumption expenditure having contracted for the first time since 1998. Private sector credit extension has also continued to decelerate, declining to 15.3% from the previous month's 16.4%.

It was another very good month for the bond market with rates across the yield curve coming down meaningfully in anticipation of declining inflation. The R153 government bond, maturing in 2010, declined by 97 bps over the month to 7.3%, the R157, maturing in 2015, declined by 161.5 bps to 7.21% and the R186, maturing in 2026, declined by 109 bps from 8.25% to 7.16%.

On the back of the cut in the repo rate money market rates also declined meaningfully over the month. The three-month NCD rate declined by 65 bps to 11.3% and the 12-month NCD rate declined by 120 bps to 9.75%.
With the economy slowing down rapidly and inflation expected to continue its sharp deceleration, the repo rate is expected to be cut at every meeting of the MPC over the next 12 months. The market is certainly pricing this in, with a bit extra as well.

The long end of the money market yield curve is beginning to look very expensive in terms of what one can expect over the next twelve months. Unless those rates move up a bit we are likely to be investing only as long as the six and nine month areas.