Upward pressure on interest rates continued this quarter, with a hike of fifty basis points in August. There was some respite for interest rates during September as the market reduced its view on the probability of an October rate hike. This came as the release of quarterly economic data showed more evidence that the demand side of the economy was being affected by the rate hikes we've had until now. However, broad-based inflation pressure remains, and we believe that we are in for a prolonged period of inflation above the top-end of the target band. This is the Reserve Bank's worst nightmare: slowing economic growth with rising inflation. It is becoming more difficult to hike interest rates under this scenario, but we would contend that the slowdown in economic growth has not been that dramatic, and that the rise in inflation needs to be nipped in the bud before it becomes structural. On this basis there should be a hike in October. There is no luxury to pause with inflation so far above the top of the band, but whether the authorities have the resolve remains to be seen. The Reserve Bank has been dovish of late, as global central banks pump much needed liquidity into markets in an attempt to prevent the impact of the sub-prime crisis spreading to the real economy. This latest shot of liquidity is seen as prolonging the emerging market and commodity cycle, increasing risk appetite for SA bonds, equity and the rand once again, and probably causing a little complacency among the authorities. For choice, we remain defensive in the portfolio, electing not to extend duration in any meaningful way given the upside risks to interest rates.

The upside risk to interest rates that RMB Asset Management has been highlighting for the past while, has become fairly predominant. The Monetary authorities resumed hiking in June after giving inflation a "get out of jail free card" by going on hold in February and April. This caused three month rates to rise to 9.42% and 12-month rates to break above 10.00%. It would appear that the authorities have got themselves behind the inflation curve i.e. inflation has broken through the top of the target band, but monetary policy actions generally only take effect in 12-18 months time. If they continue to hike now, there will be very little effect on inflation, and they run the risk of over doing the tightening. However, they need to quell inflation expectations before these get totally out of hand, and this probably means a further hike at the August meeting. While the inflation outlook has deteriorated significantly, there are anecdotal signs of the demand side of the economy starting to react to the hikes we have had to date. With this backdrop in mind, the authorities will feel that a soft landing is still on the cards, and there is no need for dramatic hikes in the future. Of course, this is predicated on global liquidity being readily available to finance our current account deficit. While there is undoubtedly upside risk to interest rates, we believe the hike in June and another in August will be all the authorities will have the will for now. We will then take the portfolios duration more overweight, with full cognizance that any withdrawal of global liquidity from emerging markets will mean further rate hikes locally.

Momentum Money Market Fund amalgamated with RMB Money Market Fund to form RMB Money Market Fund.

After a fairly dovish February MPC meeting, the market received a jolt during March as renewed inflationary pressures emerged and interest rates moved up again. Both the 3-month rate at 9.18% and the 12-month rate at 9.75% are pricing in non-negligible chances of further rate hikes. The month ended with a weak rand after another bout of emerging market risk aversion, higher oil prices, substantially higher food prices and no real evidence of any meaningful slowdown in the domestic economy.

According to our forecasts, these factors will drive inflation through the top of the band in quarter two this year. We believe the April meeting will be a very close call for a resumption of hikes, especially if they have a similar inflation profile as ours going forward. It is vital for the authorities to demonstrate credibility and vigilance by their actions. Regardless of whether they hike in April, there is upside risk to interest rates. The inflation outlook has deteriorated, while the consumer continues to spend unabated.

This has resulted in a current account deficit that is so huge that we are increasingly convinced that there is no way out of these imbalances other than to ultimately raise interest rates. We do concede that there may be a period of pause in the interim as the authorities attempt to prolong the growth prospects for the economy, to the detriment of their inflation fighting credibility. We have tempered extending duration in the fund, and are neutral at 60 days for now.

The bearish trend for short-term interest rates continued during the month. This move was driven by the fact that the SARB hiked the repo rate by 50 basis points at the December MPC meeting, and were relatively hawkish on the outlook for interest rates going into 2007, even discussing hiking a full percent. Although international sentiment towards emerging markets has become more sanguine again after the May/June bout of nervousness, the local economy continues to run at an unsustainable pace in our view. Most sectors are running at maximum capacity, demand way outstrips supply, consumer and business confidence is buoyant, leverage utilised by households is at record highs and inflation is tracking upwards with some potential pipeline pressure to come from double digit PPI. The most noticeable evidence of these excesses remains the current account deficit which continues to run between 5-6% of GDP.

It is our view that we will require a weaker rand and higher real interest rates in order to rebalance the economy, entice the consumer to save and engineer a soft landing for inflation. We are defensive in the portfolio as the risk to interest rates is on the upside. We still believe that there will be another hike at one of the meetings in the first half of the New Year, and thus remain underweight duration