In a fairly dovish statement, the South African Reserve Bank (SARB) decided to leave the repo rate unchanged at 5.5% in the September's Monetary Policy Committee (MPC) meeting. The sharp fall in the Rand towards the end of Q3 2011 probably influenced, and aided in the changing of, the original discussion of a rate cut, to the unanimous decision to leave rates unchanged. The balance of risks, downside for economic growth and upside for inflation, allowed the MPC to announce an unchanged policy rate. The Fund was positioned for an unchanged rate decision so the decision to keep the repo rate on hold, had no material impact on the Fund.

The MPC also indicated that the global and domestic growth outlook remains troubled with increasing downside risks to growth forecasts. The September statement explicitly linked the policy stance to the outlook for growth, so should growth continue to deteriorate and should the Rand recover, then the risk of a rate cut cannot be ruled out.

Over the past quarter, we have seen both inflation and core inflation tick up marginally, driven primarily by administered prices and food inflation. Rising administered prices and the recent depreciation of the rand are likely to place further pressure on inflation, something which the SARB views as a major challenge to monetary policy. The Rand price of Brent crude oil increased by 13% over the past quarter which may lead to an additional petrol price increase in the coming month. Producer Price Inflation (PPI) ticked up from 7.4% to 9.6% over the last quarter which could put additional upward pressure on inflation.

We have seen poor growth figures over the past quarter with leading indicators such as Purchasing Managers Index (PMI), manufacturing production, vehicle sales, and money supply all printing lower than the previous quarter.

We are in an environment of very low global and domestic growth, one which is likely to remain low for the foreseeable future as well as potentially rising inflation. The SARB is faced with some tough decisions ahead and there is uncertainty around what their next move will be. The Fund has a short duration, and is therefore positioned for a scenario of flat or rising rates.

On the back of weaker economic data and a slowdown in growth, the Forward Rate Agreements (FRAs) are now pricing in a 40% chance of a cut in March 2012, from previously pricing in a cut in November a few weeks ago. 3month Jibar continued to remain flat at 5.57% for the y-t-d and 1-year money market rates fell by 50bps over the past quarter. Credit spreads continued to remain flat for the quarter.

With the sharp pullback in the FRA curve, we are not seeing any yield opportunities in going long and the Fund continues to maintain short duration. Credit exposure has been increased, but remains conservative in selected issues where higher yields could be locked in. We continue to look for yield pick-up in credit and other sweeteners without taking on much duration risk.

Gill Marcus, Governor of the SARB, stated that there were no obvious threats to domestic financial stability for now, but cautioned that the inflation outlook was being adversely affected by higher commodity prices. In May, Headline Inflation, Producer Price Inflation (PPI) and M3 Money Supply all rose marginally, whilst Private Sector Credit Extension (PSCE) and the Purchasing Managers Index (PMI) surprised to the downside.

Headline inflation surprised on the upside, coming in at 4.6%, which was above the consensus forecast of 4.4%. The negative surprise was due to a 1.7% m-o-m increase in food prices which took annual food inflation from 4.8% to 6.3%. Core inflation, however, remained benign at 3.2%.

PPI continued to increase, rising from 6.6% to 6.9%. This was lower than consensus expectations of a PPI print of 7.1 %. This uptick in PPI was driven by higher global commodity prices and high administered price increases (electricity).

PSCE declined from 6.2% to 5.2% in May. This was substantially lower than the consensus forecast of 6.3%. June PMI dropped over the month from 55.1 to 53.9 on the back of the moderation in global growth. Softer manufacturing growth followed on the back of the low PMI print. The moderation in PSCE and PMI should cap tightening expectations in the market.

Despite high levels of volatility, the Rand/US$ and the price of Brent Crude remained fairly flat across the entire month.

The Forward Rate Agreements (FRA's) have come off a bit over the past 3 months with the market currently pricing in 125bps worth of rate hikes over the next 12 months and 200bps hikes within the next 24 months.

Since the curve has started to shift up, we are starting to see some yield pick-up opportunities at the longer end, and we will look to take advantage of this at some point. Credit exposure has been increased, but remains conservative in selected issues where higher yields could be locked-in. We continue to look for yield pick-up in credit and other sweeteners without taking on much duration risk.