August 27, 2004

By From Reuters and Sapa-AFP

Johannesburg - Government bonds rallied yesterday while the rand firmed after news of a surprise fall in producer prices in July, which eased concern about the inflation outlook and fuelled hopes of more interest rate cuts.

Bond yields rallied by about a quarter of a percentage point after official data showed that the producer price index fell 0.2 percent in July. Its annual increase slowed sharply to 0.7 percent.

Following news on Wednesday of benign consumer price rises during the same month, the data provided more justification for the central bank's decision to trim its repo rate 50 basis points to 7.5 percent two weeks ago.

Analysts said the market, which had initially expected interest rates to rise later this year, had begun to price in the possibility of a rate cut in October.

"It has added credence to the central bank's opinion of the inflation outlook. Clearly, underlying inflation is less than feared," said Barclays' fixed-income strategist, Leon Myburgh.

"We may see some more gains in bonds in the near term, but I think the scope is limited at the long end. Short dates may make more gains as sentiment increasingly favours more rate cuts."

But like many other analysts, Myburgh thought the expectation of more rate cuts was misplaced given the potential for upward price pressure from rising oil prices and strong local demand.

Local dealers said many players had been caught short after the producer inflation numbers, and breaks of key technical levels had spurred gains in bonds.

By 5pm the R194 had rallied 27.5 basis points to 8.425 percent bid. The R153 had strengthened 28.5 basis points to 8.835 percent.