S.Africa's rand weaker but demand props up bonds

JOHANNESBURG: South Africa's rand weakened more than 1.1 percent against the dollar on Friday but was cushioned from further losses by strong foreign demand for local bonds which are still offering significant yields despite a surprise interest rate cut.

The rand hit a session low of 8.2797 to the greenback, its softest since Monday, but came back slightly to 8.2650 by 1800 GMT, down 1.1 percent on the day.

The rand tracked the euro, under renewed pressure following a spike in Spanish bond yields. The debt crisis in the bloc, a key trading partner for South Africa, continues to weigh on risk sentiment.

"Since Europe came in we've just seen one-way traffic with the euro getting hammered again on concerns over Spain and global growth," said Bidvest Bank chief dealer Ion de Vleeschauwer.

South Africa's official rate cut on Thursday "caught some people by surprise and that's also going to put a bit of pressure on the local currency," he added.

The Reserve Bank cut its benchmark repo rate by 50 basis points to 5.0 percent, citing a weaker economic outlook while inflation was seen benign.

On Friday, government bond yields hovered close to the previous day's record lows as some market players bet that another rate cut could be on the horizon later this year.

The yield on the three-year benchmark was down seven basis points on the day at 5.39 percent while that for the 14-year paper shed six basis points to 7.195 percent.

On the short-term money market, forward rate agreements, a pointer to interest rate expectations, were also pricing in another cut in 2012.

"The market at the moment is pricing in a 40 percent chance that we'll see another cut in September and a 50 percent chance that we'll see one thereafter if we don't have one in September," said Sijadu Mzozoyana, a trader at Investec.

Despite Thursday's rate reduction, South African assets still offer better returns than instruments in more developed countries.

The country's pending inclusion in Citigroup's World Government Bond Index in October has also fuelled demand for local debt by foreign accounts, propping up the rand.

"The search for yield is so difficult these days that the rand is actually not doing too badly. Although our yields are slowly diminishing, they're not at zero as is the case in many developed countries," said Bidvest Bank's de Vleeschauwer.