March 22, 2012 / 4:10 PM / 8 years ago

S.African bonds rally on CPI, rand weakens sharply

* Bonds gain as CPI dents case for rate hike

* Rand tracks other commodity currencies weaker

JOHANNESBURG, March 22 (Reuters) - South Africa’s government bonds rallied on Thursday after domestic inflation surprised the market to the downside, backing the case that the Reserve Bank might not have to increase interest rates after all this year.

The rand extended losses against the dollar, however, and was also weaker versus the euro, partly on dented prospects for higher rates and also in tandem with weaker commodity currencies elsewhere as worries about the global economy resurfaced.

The yield on the benchmark three-year bond closed five basis points lower on the day at 6.89 percent.

It was at 6.97 percent just before Statistics South Africa reported that CPI braked unexpectedly to 6.1 percent year-on-year in February from 6.3 percent in January.

The yield on the longer-dated 2026 issue fell three basis points to 8.515 percent.

“The CPI data was a reprieve for the market. I don’t see the market rallying too much further but it’s comforting knowing that inflation isn’t rocketing like some people anticipated. It’s given the market a bit of a pause and some breathing space,” said Steve Arnold, a bond trader at Investec.

Government bond prices have sold off sharply over the past week, pushing yields to their highest levels since mid-December, as the market saw it as highly likely the Reserve Bank would resume monetary tightening by year end to curb inflation.

“I still think the market’s long but I think that today’s data would give a lot more credence to the camp that believes that rates will stay unchanged for longer,” Arnold said.

The yield curve on the 2015 and 2026 paper steepened slightly as the short-end of the market enjoyed a boost from the CPI data.

Prospects of interest rates staying at 30-year lows for longer weighed on the rand, which was also hit by waning risk appetite on renewed recession worries in Europe, where South Africa does a large chunk of its international trade.

The rand hit a session trough of 7.75/dollar, the weakest it has been in a month, and was 0.95 percent weaker at 7.7220 by 1546 GMT. (Reporting by Stella Mapenzauswa; Editing by Catherine Evans)

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