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Rate cut talk brews

Consumer inflation in South Africa slowed to within the central bank's 3-6 percent target range in May, surprising markets on Wednesday and raising expectations that the central bank may have room to cut interest rates this year.

Headline inflation was at 5.7 percent year-on-year in May from 6.1 percent in April, compared to economists' expectations of 5.95 percent, data showed on Wednesday.

Food inflation dropped sharply to 6.6 percent on an annual basis and was at -0.2 percent month-on-month from flat in April. Transport costs also declined.

“It confirms to us that inflation in South Africa is not a real problem any more despite the rand exchange rate's recent depreciation. I think we will see a benign inflation environment,” said Elize Kruger, an economist at Kadd Capital.

Earlier this month Reserve Bank governor Gill Marcus sounded concern about the upside risk that a depreciated exchange rate had on her inflation outlook.

The rand plunged to a 3-year low of 8.71 against the dollar on June 1 as the festering euro zone debt crisis hit emerging markets.

It had recovered to 8.20/dollar by Wednesday, mainly as investors expect the US Federal Reserve to announce some form of monetary easing that would result in increased foreign flows to emerging markets.

On a month-on-month basis inflation also surprised to the downside, easing to 0.1 percent compared to 0.4 percent in April. Economists had expected month-on-month prices would remain unchanged.

Economists are now starting to talk about the central bank in Africa's biggest economy contemplating an interest rate cut - although not as soon as next month's monetary policy decision.

Analysts say the global growth outlook may need to deteriorate further to trigger a reduction in the benchmark lending rate.

“We continue to believe that the Reserve Bank will leave interest rates unchanged this year,” said Annabel Bishop, an economist at Investec.

“But should the global outlook deteriorate significantly, the Bank is likely to cut by 50 basis points in Q3 2012.” - Reuters

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