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By Vernon Wessels

Johannesburg - Expectations of an interest rate cut in August of at least 1 percentage point were cemented yesterday, after producer price inflation slowed to its lowest level in history, boosting bonds and the rand.

The stronger rand and lower oil prices pushed the producer price index (PPI) to 1.1 percent in May from 3.3 percent in April, according to data released by Statistics SA.

The PPI shows the rate of increase in the prices producers charge retailers.

Stats SA data only go back to 1975, although data on Bloomberg show that the latest figure is the lowest level for PPI since January 1971.

The market, which had expected a 2.6 percent rise in PPI, was stunned and sent bonds to fresh highs.

Short-term gilts strengthened sharply as the market factored in more aggressive interest rate cuts by the Reserve Bank.
The yield on the R150, due in 2005, strengthened by 40 basis points to 8.91 percent shortly after 5pm, while that of the R153, due in 2010, improved to 8.93 percent from 9.13 percent on Tuesday.

The rand rallied with bonds and a firmer euro to a best of R7.6406 against the dollar before retracing to R7.6624 shortly after 5pm from R7.7610 on Tuesday.

Chris Hart, a senior treasury economist at Absa, described the PPI data as "staggering".

"The debate for the Reserve Bank's monetary policy committee meeting in August will now revolve around whether interest rates will be cut by only 1 percentage point or by 1.5 percentage points," he said. "A cut of 1 percentage point is a dead certainty."

Absa expected cuts of at least 3 percentage points by February next year  
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The market had overestimated inflation because "no one can test their inflation models, as we do not have the experience of a strong rand".

The rand has gained almost 12 percent against the dollar this year after rising 40 percent last year.

If the rand strength was maintained, the Reserve Bank might undershoot its inflation target of between 3 percent and 6 percent for CPIX (consumer inflation excluding mortgage rates), Hart said.

Producer prices tend to lead consumer prices by at least three months.

Dawie Roodt, the chief economist of PLJ Financial Services, said producer inflation could be pushed into deflation as soon as August.

He expected interest rates to be cut at least another three times this year, with a fourth cut likely in February next year.

Monica Ambrosi of Standard Bank said the Reserve Bank might cut rates by 1.5 percentage points in August, following a surprise reduction of 1.5 percentage points earlier this month.

"With prices having tumbled so fast and furious at the producer level, price moderation at the consumer level is expected to intensify in the months ahead."

The biggest contributors to the decline in PPI were mining and quarrying, petroleum and coal products, and processed food, said Elaine van Heerden of m Cubed Asset Management.

Imported PPI fell from minus 1.4 percent in April to an annual rate of minus 4.8 percent in May, while local PPI came in at 3.4 percent compared with 5.1 percent in April.