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JOHANNESBURG, June 7 (Reuters) - South African bonds priced in a higher likelihood of a 50 basis point rate cut by the central bank sooner than anticipated after the economy unexpectedly slipped into recession and raised the risk of further credit downgrades.
Forward rate markets on Wednesday were pricing in a nearly 30 percent chance of a 50 basis point interest rate cut at the next policy meeting in July, up from a 9 percent probability seen before the May policy meeting.
The South African Reserve Bank (SARB) has treaded a cautious policy path in the last 18 months, keeping benchmark rates on hold at 7 percent while signalling it had reached the end of a tightening cycle that began in early 2014.
The bank may however be pushed to act to save the economy by cutting lending rates sooner than planned to make money cheaper in a bid to boost consumer spending, analysts said.
Data on Tuesday showed the economy contracted by 0.7 percent in the first quarter of 2017 after shrinking 0.3 percent in the fourth quarter of last year.
At its policy meeting in May, Reserve Bank Governor Lesetja Kganyago played down the prospects of cheaper borrowing costs, citing risks to inflation posed by currency volatility in light of domestic political uncertainty and credit ratings downgrades.
Economists also said risks to inflation and the currency, posed by large capital and trade deficits, had faded.
"For a whole host of reasons the prospect of a rate cut has definitely increased. The bank could very well prioritise growth, putting it higher than has been case where inflation has been front and centre," said director ETM Analytics George Glynos.
"These traditional drags on the rand are no longer there and as a result they will probably feel a lot more comfortable in reducing interest rates."
The country's trade balance swung to a 11.4 billion rand surplus in March and has remained in the black since then, while the current account narrowed to a six-year low in the first quarter.
"Cutting next year would be too late and that will have driven the economy into a permanent recession," said senior economist at Old Mutual Johann Els.
"Cutting rates now would potentially boost confidence and the growth outlook and that would be positive for rating expectations because the agencies have said they're looking for growth possibilities that will aid fiscal sustainability." (Reporting by Mfuneko Toyana; editing by Mark Heinrich)