How low can we go? The September Monetary Policy Committee (MPC) meeting saw the SA Reserve Bank cut the repo rate by a further 50 basis points (bps) to 6%, the lowest policy level since 1980! Contrary to previous MPC meetings, the interest rate decision for September was a unanimous one. The market was also unanimous as all the economists polled by Bloomberg expected the 50 bps cut in the repo rate. The driving factors behind the rate cut as cited by the SARB governor was the improved inflation outlook, the consistently strong rand, the slowdown in the domestic recovery (revised SARB 2010 GDP growth forecast 2.8% from 2.9%) and the fragile global economy. Inflation declined even further since the last quarter and is expected to remain within the target range for the foreseeable future. PPI surprised well above market expectation, rising to 7.8% y-o-y. This, however, does not pose a threat to the favourable inflation outlook as this increase was mainly attributed to higher commodity prices. Commodity price gains are expected to be contained during the remainder of the year due to slower global growth. Credit growth improved over the quarter, thanks to low interest rates and an improvement in household finances, household demand for credit rose further. Although the demand for credit has improved, the level of debt-to-disposable income remains high, and this is why the economic recovery will remain a slow one. On the contrary, corporate credit demand remains suppressed as firms remain wary of increasing capital expenditure due to ample spare capacity. The fragile recovery is expected to continue. The portfolio continues to outperform the benchmark STeFI Composite Index. The portfolio is exposed largely to banks (89% in September), with the remaining 11% invested in Government securities or short-term corporate debt. The scope for further rate cuts seems limited. However, a further rate cut cannot be ruled out should growth disappoint or new data emerge that indicates that the consumer recovery is faltering. Under the current market conditions, the portfolio will maintain its high exposure to floating-rate assets.

Dismal credit growth numbers, benign inflation, local currency strength and the PIGS problem (ie the Portugal, Italy Greece and Spain economic crisis) were the dominant factors over the past quarter that kept the interest rate pendulum swinging to-and-fro at MPC meetings. Internationally, the euro EU/IMF rescue package appears to have muted an escalation in the sovereign debt crisis. However, growth in the EU is expected to be subdued due to severe austerity measures imposed on countries involved in the bailout.

On the local front, the recovery seems to be on track and gained further pace in the first quarter of 2010. GDP rose strongly in the first quarter of the year, albeit coming off a low base. The economic outlook is promising and household demand is expected to remain firm on better employment prospects, lower interest rates, income growth and the FIFA world cup.

After experiencing three quarters of contraction, household and government expenditure rebounded - rising by 5.7% q-o-q and 7.3% q-o-q. Household debt to disposable income improved to 78.4% from 79.9% in the previous quarter. The level of debt to disposable income remains high, and this is why the economic recovery will remain a slow one.

Inflation declined even further since the last quarter, and it is expected to continue its downward path in the foreseeable future. Rand strength, weakness in demand and the base effect are all key factors in the ongoing moderation in inflation.

The portfolio continues to outperform the benchmark STeFI Composite and is exposed largely to banks (89% in June) while 11% of the portfolio is in Government securities or short-term corporate debt. With the recovery being on track, albeit slow, interest rates are expected to stay unchanged until well into 2011. However, a further rate cut cannot be ruled out should growth deteriorate or new data emerge that indicates that the consumer recovery is faltering. The yield curve supports our view suggesting flat to rising rates over the next 12 months. In anticipation of an upward rate cycle, the portfolio will maintain its high exposure to floating rate assets.

The new repo rate of 6.50% set by the South African Reserve Bank (SARB), following the 50 basis points (bp) rate cut in March, resulted in the lowest policy level. The decision by the MPC was unanimous, while the majority of economists expected rates to be left unchanged.

The SARB mandate was further clarified with the Minister confirming that monetary policy will be shifted from the traditional inflation-targeting framework to incorporate other factors such as growth and employment. According to a Reuters report, the minister has said "the country's central bank has been taking jobs into account when making interest rate decisions and it is clear that it should do so."

CPI inflation fell back within the 3%-6% target band in the course of last month mainly due to rand strength and statistical base effects. The overall consensus for the inflation outlook seems positive, with inflation expected to remain below 6% for the remainder of the year.

Credit statistics remain weak. The latest money supply and PSCE figures (the fifth successive month of decline) shows that consumers are still struggling due to high indebtedness, which has been compounded by job losses (870,000 jobs lost last year). This was a factor in the SARB's decision to drop interest rates. The lower interest rates will alleviate some pressure from indebted consumers who will also continue to opt for cash purchases as opposed to credit for some time until their debt levels improve. With credit demand expected to remain low, we expect a slow economic recovery as opposed to a sudden rebound.

Overall, the local economic outlook is positive. Globally, the rebound is moderate with benign inflation. The rand has firmed by 6% to the US dollar on a trade-weighted basis since the January MPC meeting. Although this is positive for inflation, it poses a risk to our export sector. As it stands, there seems to be no risk of demand inflation, however, high increases in administered prices as well as wage settlements remains a concern.

The portfolio continues to outperform the benchmark STeFI Call Rate and continues to be exposed largely to banks (91% in March), while 9% of the portfolio is in Government securities or short-term corporate debt.

Following the latest cut, we think the SARB will keep interest rates unchanged well into 2011. However, if the inflation outlook improves materially or economic and credit statistics deteriorate, another 50 bp cut cannot be ruled out. The yield curve supports our view suggesting flat to rising rates over the next 12 months. In anticipation of an upward rate cycle, the portfolio will maintain its high exposure to floating rate assets.

The fourth quarter has seen the South African Reserve Bank (SARB) holding back on monetary policy easing. Inflation continued its downward trend this quarter and edged to within the target range in November, continuing this trend for the second consecutive month, ending the quarter at 5.8% y-o-y from 6.4% y-o-y the previous quarter. Inflation is expected to hover around the upper end of the target range for the most part of 2010. However, there are four factors that could have a material impact on this inflation outlook: the strength of the rand; domestic demand; Eskom's proposed 35% tariff hike; and international commodity prices.

Economic statistics remain weak. Money supply and private sector credit extension (PSCE) continued to retract. Growth in credit fell to its lowest level of -1.6% y-o-y, (its strongest contraction since 1965) coming in much weaker than the market's expectation, despite lower interest rates. The decline in PSCE growth indicates that SMEs and corporates continue to be under severe strain. Companies are still cutting back on investment plans. This is due to banks' lending criteria remaining relatively tight and strained domestic demand as consumers remain burdened by high debt levels and rising unemployment. PPI deflation continued throughout the quarter, but at a more moderate pace.

The South African economy is officially out of a recession after recording a positive GDP figure in the last quarter (following three consecutive quarters of shrinking) and experiencing a rebound in manufacturing production. Exports are starting to respond to improved global conditions. The 2010 FIFA World Cup is expected to help lift activity levels, however, the recovery is expected to be slow and businesses and households will feel the downturn well into 2010.

The market's consensus is for the SARB to keep interest rates unchanged for most of 2010. While inflation-targeting remains a priority for the SARB, the risks to interest rates remain to the upside. However, the dismal economic indicators suggest that the recovery remains weak and therefore, a last ditch rate cut to further stimulate growth, cannot be ruled out.

The fund continues to outperform the benchmark STeFI Call Rate.

The fund continues to be exposed largely to banks (91% in December) while 9% of the fund is in Government securities or short-term corporate debt.

Market sentiment indicates that we have reached the bottom of the interest rate cycle; although a further 50 basis point cut at future MPC meetings cannot be ruled out.

The bias though remains towards flat rates for the most part of 2010 -the yield curve suggests rising rates towards the end of 2010. With the SA economy technically out of recession, despite the release of dismal economic statistics, the timing of the first interest hike has potentially been brought nearer. In anticipation of an upward rate cycle, the fund will maintain its high exposure to floating rate assets.