* Reserve Bank seen leaving rates on hold
* Market divided on timing of rate hike
* Early rate hike would curb economic growth
* Retail sales weak, consumers wary
(Combines inflation, retail sales, market reaction)
JOHANNESBURG, July 20 (Reuters) - Annual growth in South Africa's retail sales was flat in May and inflation quickened more than expected in June, highlighting the dilemma the Reserve Bank is facing in containing inflation without hurting an already-weak recovery.
The Reserve Bank is largely expected to leave the repo rate unchanged at 5.5 percent on Thursday, when the focus will be on any clues policymakers give about when rates will start rising from 30-year lows after 650 basis points worth of reductions between December 2008 to the end of 2010.
So far, the market is divided on the timing of the monetary tightening cycle, with 12 out of 21 analyst polled by Reuters last week seeing interest rates starting to rise before year-end. [nL6E7IF0ZS]
The central bank has previously said it will be vigilant on any signs of inflation risks emanating from demand and will not hesitate to tighten policy.
But, it is loathe to tighten monetary policy just on food and fuel prices alone, which have been the main drivers of inflation that have helped to raise it from 5-year lows in September last year. [ID:nLDE75K0EI]
Statistics South Africa on Wednesday said retail sales growth was flat on an annual basis in May while inflation rose to a 15-month high of 5.0 percent year-on-year in June, mainly due to food and fuel prices. [ID:nJ8E7HE003] [ID:nJ8E7HE004]
Government bonds extended gains after the retail sales data as the market moved to position for sideways movement in rates this year. [ID:nL6E7IK0LF]
The forward rate agreements have also pointed to softening rate rise expectations, with the rate on the 4x7 contract falling to 5.67 Wednesday from 5.84 in mid-June.
"I was expecting Q4, but I think Q1 is when a hike is going to happen," said Colen Garrow, an economist at Brait, changing his rates view after the retail sales data.
Retail sales were the main driver of growth before the recession in 2009. The recovery has been anaemic and the economy is expected to grow by 3.4 percent this year, a fraction of the 7 percent the government has said is needed to reduce unemployment from 25 percent of the labour force.
The government last year expanded the Reserve Bank's mandate, asking it to also consider growth and employment in its monetary policy decisions.
More than a million people have lost jobs since the recession and with those that are unemployed hesitant to spend, the Reserve Bank might be reluctant to tighten monetary policy too soon.
The manufacturing sector, the second largest contributor to GDP has also been sluggish with a bleak outlook given the global economic slowdown. [ID:nLDE76B0WB]
"Latest statistics on local and international growth have not been encouraging and we would therefore still expect the Reserve Bank ... to delay its first hike until early 2012, as an early interest rate increase would risk curbing the economic recovery," said Nedbank in a note.
The rise in inflation might not be that much of a surprise to the Reserve Bank that sees inflation breaking outside its 3 to 6 percent target to peak at 6.3 percent in the first quarter of 2012.
Administered prices, such as electricity prices and municipal rates, are likely to add to inflationary pressures over the next few months.
"Core inflation increased by 3.5 percent y/y from 3.2 percent, indicating that demand driven inflation is starting to rise," said Investec in a note, calling for a rate increase in the fourth quarter of this year.
"The SARB will monitor it closely to gauge underlying demand push inflationary pressures," the company said, it could change its view after the rate decision on Thursday.
The Reserve bank will likely to warn on double-digit wage demands, which have led to strikes at some companies in the mining, chemical industries. [ID:nL6E7IE1MA]
(Reporting by Phumza Macanda; editing by Ron Askew)
((Phumza.Macanda@thomsonreuters.com)(+27 11 775 3152)(Reuters Messaging: RM: email@example.com)) Keywords: SAFRICA ECONOMY/
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