ALL eyes will be on the Reserve Bank this week to see whether its monetary policy committee (MPC) cuts interest rates on Thursday. Most economists, however, expect the committee to err on the side of caution and keep the repo rate unchanged at 13,5%.

Consumer price inflation figures for last month, which will be released ahead of the MPC's two-day meeting, are expected to have slowed. The rand's appreciation in the past 12 months, and lower food prices, have eased inflationary pressure in recent months. The Bank's targeted inflation rate, CPIX (consumer inflation excluding mortgage costs), slowed to 11,8% in January from a peak of 12,7% in November.

Economists expect CPIX in February to remain above the 11% mark, which is still significantly higher than the inflation target's upper limit of 6%. This may prompt the Bank to delay a rate cut until later this year. The Bank's governor, Tito Mboweni, said in January that inflation should be "moving significantly in the right direction" before there could be speculation on a cut in interest rates. Analysts expect inflation to fall within the target by the end of the year or the first quarter of next year. Government adjusted the target last year, raising the upper limit by one percentage point.

The Bank must limit CPIX to between 3% to 6% by 2004.

John Stopford, Investec Asset Management's fixed-income strategist, says high unit labour costs are likely to remain a concern for the MPC this week, despite consumer inflation slowing in recent months.

"The Bank is likely to be cautious because the target has already been adjusted for next year. Its credibility is more on the line now because of the easier target. If it does not meet the target next year, it may not be taken positively by the market."

The bond market is likely to be subdued if interest rates remain unchanged this week, as the market expects. Most economists expect the first interest rate cut to take place at the MPC's next meeting in June. "The bond market will look at signs in the MPC statement as to when interest rates are likely to come down. If the market reads into the statement a very cautious stance (that the rate cut will be delayed beyond June) there is likely to be a selloff," Stopford says.

An interest-rate decision may also affect the exchange rate, which has for the most part been boosted this past year by foreigners buying high-yielding interest rate assets.

Some economists predict a rapid fall in interest rates will weaken the rand as capital inflows slow or turn negative. An early rate cut may also add to the volatility of the currency, which would damage business and investment sentiment. Last week the rand weakened above R8 to the dollar for the first time this month.

Rand volatility, coupled with higher oil prices, have created additional uncertainty about inflation prospects, which will prompt the MPC to be cautious, economists believe. JP Morgan economist Taryn Rebeck says the first rate cut may be delayed until September, since CPIX is still likely to be in double digit figures when the MPC meets in June.

Despite the stronger rand having positive spin-offs for the inflation outlook, high unit labour costs and high administered prices all of which were cited as matters of concern by the MPC in November show no "convincing signs of moderating", Rebeck says.

There are concerns, however, that high interest rates may adversely affect manufacturing output the engine of economic growth. Recent data shows tentative signs that the stronger rand, high interest rates and weaker global demand have taken their toll on manufacturing output. However, this may be countered by tax cuts, which should support consumer demand.