S.Africa hit by global turmoil, bond yields driven down

Gloomy comments from South Africa's central bank on the impact of global financial turmoil on the country's capital formation, key to growth, were the backdrop to a fall in bond yields and a volatile day for the rand, which ended down against the dollar.

Analysts on Wednesday said Africa's biggest economy, heavily dependent on the wider global economy's health, will be hurt by the uncertainty stemming from sovereign debt worries in the U.S. and Europe.

The bond market was starting to price in the slim chance of rate cut to counter this, traders said.

"South African has been largely reliant on a strong external recovery ... to kick off the domestic turnaround," said Peter Attard Montalto, an emerging markets analyst at Nomura.

"A loss of external momentum can, in my view, exemplify how fragile the domestic economy is and, in the case of an external second recession, lead to a much more painful outcome for South Africa."

A survey showed confidence among South African businesses fell to its lowest level so far this year in July, weighed by the bleak global outlook.

Officials from the Reserve Bank said fixed capital formation -- the expenditure on fixed capital assets such as buildings and machinery crucial to the country's economic growth -- had also been hit by the uncertain climate.

"Elevated uncertainty is not the friend of fixed capital formation and that is what South Africa dearly needs," Johan van den Heever, senior deputy chief economist at the central bank told legislators during a presentation on the Reserve Bank's quarterly bulletin originally released in June.

"It has been rising slowly in recent quarters but we want more of that and this environment is not good for further fixed capital formation."

Bank officials told members of parliament consumer spending was expected to underpin growth in the economy even as external uncertainties remain, but recent data shows indebted households are still reluctant to spend after a recession in 2009 which slashed a million jobs.

The Treasury expects growth of 3.4 percent this year as the economy slowly recovers, helped by 650 basis points of interest rates cuts in the two-years to November last year -- but some analysts see a lower outcome as global growth s.

BUSINESS CONFIDENCE FALLS

The South African Chamber of Commerce and Industry (SACCI) said on Wednesday its business confidence index fell to 99.0 in July from 102.4 in June, adding global and domestic economic conditions were not conducive to sentiment.

"Serious fiscal instability in advanced economies and even in some emerging and developing economies, as well as lacklustre investment performance, pose the threat of another economic slowdown barely 23 months into the upward phase of the business cycle," it said.

The Reserve Bank has kept rates steady so far this year, and markets had been expecting them to start rising by year-end as inflation increases.

But government bonds rallied sharply on Wednesday, pushing yields to multi-month lows, as market players started pricing in the slight chance the economy might need further stimulus by way of at least one more rate cut.

"The market is pricing in a very soft interest rate forecast out until mid 2012 to the end of 2012," said Chris Becker, a market analyst at ETM.

"Looking at FRA's (forward rate agreements)the market is beginning to price -- albeit very small -- but still the possibility for another rate cut and that's what's keeping bonds quite firm."

The rand weakened sharply against the dollar, and was last down 2.67 percent at 7.2950, ranking about the five worst performers in a basket of emerging market currencies monitored by Reuters.

But traders said the currency's volatility -- it earlier strengthened to a session high of 7.0750 -- had little to do with domestic news, taking most of its cue from the euro, currency of one of South Africa's key trading partners.

"It's nothing local. It's the U.S. downgrade and the threat of global economic downturn again and that's just pushing the rand round about at the moment," said Ion de Vleeschauwer, a dealer at Bidvest Bank.