THE Reserve Bank is expected to hold interest rates steady when its policy meeting ends this week, but is also likely to warn markets not to take anything for granted in the months ahead. Prospects of a recession in some of SA?s main trade partners, slower growth in the domestic economy, and global financial turmoil would all back a decision to keep the repo rate on hold at 12%. But the near-term inflation outlook has deteriorated after a sharp slide in the rand last week ? which is set to erase some of the benign effects of a dramatic fall in global oil prices.

?My feeling is that the Bank will keep interest rates on hold but its rhetoric could be very hawkish due to the rand,? said Brait economist Colen Garrow. ?If the rand spikes over R9 to the dollar there is a slight chance rates will go up.? In the past couple of days the rand has skidded to successive five-and-a-half-year -year lows against the dollar, briefly touching R8,57 last week as global risk aversion took its toll on emerging markets. Currency weakness pushes up inflation by making imports more expensive. The rand depreciated by more than 5% to the dollar last week alone, taking its losses this year to about 20%.

That has cast a cloud over the inflation outlook, which analysts still expect to improve significantly at the start of next year, paving the way for interest rate cuts. Reserve Bank Governor Tito Mboweni moved to damp that speculation last month, telling Parliament?s finance committee that inflation would be ?higher than expected? next year. ?The situation is still very serious and we have to attend to that,? he said. Inflation measured by the annual rise in CPIX accelerated to a record 13,6% in August, marking the 17th month in a row above its official 3%-6% target. The Bank has raised lending rates by five percentage points between June 2006 and June this year to curb inflation, ignited by the soaring global cost of fuel and food. But it kept interest rates steady at its last monetary policy committee (MPC) meeting in August, and all 26 analysts polled by Reuters last week expected it to do the same thing now. ?It seems pretty certain that the MPC will keep rates on hold,? said Goldman Sachs economist Ashok Bhundia. ?But it may keep them on hold for longer, despite the global shocks in the pipeline.? Analysts expect central banks in the US, Europe and Britain to cut interest rates soon, to boost economies hammered by fallout from the global credit crunch.

Local markets are betting that interest rates will start falling in SA in February or April next year, with a cumulative decline of three percentage points by early 2010. That stems from the view that inflation will dive between two and three percentage points in January, after a radical overhaul of official consumer price indices. The measures are being re-weighted and re-based in a regular five-year exercise which will more accurately reflect household spending patterns and prices.

Since changes in interest rates take 18-24 months to take effect, the Bank bases its monetary policy decisions on that time horizon. Forecasting is complicated by official plans to switch from targeting CPIX ? which excludes home loan costs ? to the broader CPI measure, which is a bit higher. The Bank will also have to consider the latest quarterly inflation expectations survey from the Bureau of Economic Research (BER) at its meeting this week.

Its overall message is likely to be grim, as price expectations of trade unions and business leaders have probably worsened. That could offset an improved inflation outlook from financial analysts. ?Inflation has continued to surprise on the upside,? Bhundia said. ?The cap is strong public debate about what will happen to inflation next year so that could affect perceptions. Otherwise I expect further upside momentum.?

The BER?s last quarterly survey showed the public believed inflation would stay outside its target range this year, next year and in 2010. That is not far from the Bank?s forecasts that CPIX will subside below 6% by the second quarter of next year. Mboweni repeated last month that the Bank had to anchor inflation expectations, which feed rapidly into prices and wages. Failure to do so could result in a ?further acceleration of inflation?, he said. The decision of the MPC is due on Thursday.

Manufacturing data for August are due on Wednesday, and are likely to reinforce evidence of slowing growth. Citigroup economist Jean-Francois Mercier is predicting a second monthly fall in output from the sector, the economy?s second-biggest. Details of a quarterly consumer confidence survey from the BER and FNB on Tuesday are set to show another drop in sentiment after the steepest plunge in 24 years in the second quarter.

?Our forecast would ? imply the lowest reading since the fourth quarter of 2002, and be consistent with a further weakening in consumption growth,? Mercier said.