Johannesburg - Bonds, among the best-performing government debt this year, were set to extend gains in the next six months as inflation slowed and the Reserve Bank cut interest rates, analysts and investors said yesterday.

The rand might weaken.

The rank was likely to keep cutting interest rates, economists said. Further reductions from the current 12 percent level might send the yield on the R153 down after it plunged to a record low 8.92 percent on June 17 from 10.68 percent on January 2.

Natheem Alexander, who helps manage bonds and cash at Abvest Associates, said: "Against that sort of backdrop, you have to be positive

Alexander recommends buying the R153, which pays interest of 13 percent. The yield on the R153 might fall as low as 8.50 percent by the end of the year, from 9.12 percent yesterday, he said.

Targeted consumer price inflation less mortgage costs (CPIX) might drop to within the Reserve Bank's 3 percent to 6 percent range by December, setting the stage for lower rates, analysts said.

CPIX slowed to an annual 7.7 percent pace in May, from 8.5 percent in April after four Reserve Bank rate increases last year of 1 percentage point each.

The R153 returned 9.6 percent, including reinvested interest, between June and September 2001 when the bank cut rates three times for a total of 2.5 percentage points.
Slowing inflation preserves the value of future bond coupon payments.

Government bonds maturing in seven to 10 years returned more than 13 percent this year, including reinvested interest, without adjusting for the currency, according to indices compiled by the European Federation of Financial Analysts' Societies.

On a currency-adjusted basis, the bonds returned 22.86 percent and were the world's sixth best performer.

Conrad Wood, a fund manager at RMB Asset Management, said bonds would continue to gain on "fairly aggressive cuts in short rates". "Inflation will hit the target, so the central bank has no excuse not to cut."

RMB expects inflation to slow to an average of 4.5 percent next year, giving the Reserve Bank room to cut the repo rate by as many as 4.5 percentage points over the next 12 months.

Wood holds more R153 bonds than the percentage in the Bond Exchange of SA's all bond index, the benchmark he follows. The yield on the R153 might fall as low as 8 percent in the next 12 months, he said.

High interest rates helped fuel the rand's 29 percent advance against the dollar since June 2002. The Reserve Bank's repo rate of 12 percent compares with US and European central bank benchmark rates of 1.25 percent and 2 percent, respectively.

The rand, which reached a 32-month high of R7.053 against the dollar on April 30, would probably decline to about R8.50 against the dollar by year-end, from R7.7876 against the dollar in late afternoon trade yesterday, according to the median estimate of seven economists surveyed by Bloomberg News.

Estimates ranged from R8.20 to R9 against the dollar. Lower rates may curb some of the rand's 7.7 percent advance this year.

Rian le Roux, the chief economist at Old Mutual Asset Managers, said the rand would fall because the "foreign trade balance will probably deteriorate, and the narrowing of the gap between our interest rates and those of our trading partners has started".

Le Roux sees the rand between R8.30 and R8.60 against the dollar by the end of the year.

Lower interest rates might fuel economic growth, limiting the currency's decline and narrowing the gap between yields on local and other bonds, investors said.

Reserve Bank rate reductions of 3 percentage points would bring the real interest rate next year - the repo rate minus the expected inflation rate of 4.5 percent - to 4.5 percent, still higher than the benchmark rate in the euro zone and the US.

Deon van Zyl, who oversees fixed-interest investments at Metropolitan Asset Managers, said: "Interest rate cuts may bring the differential down, but the differential will still be there."

Lower rates "are good for the economy, so there's a negative and a positive".

Van Zyl sees the rand weakening to R8.50 against the dollar by the end of the year as the Reserve Bank cuts its repo rate by 3 percentage points. He holds more R153 bonds than the percentage in the all bond index.

The country's five-year bond yields 8.99 percent compared with 2.20 percent for the five-year US treasury note and 2.83 percent for the German bund of the same maturity. - Bloomberg