In South Africa, along with our usual burdens, one of which is continued load-shedding, we also have to contend with seemingly ever-increasing interest rates. Last week, the South African Reserve Bank (SARB) elected to increase interest rates again. This was the seventh consecutive increase in the previous 12 months, leaving interest rates above pre-pandemic levels.
So, what is driving their decision to increase rates, and how do these interest rate hikes ultimately affect us as consumers?
Taking a step back, we need to understand the driving factors behind this inflationary environment, and, in turn, the interest rate hikes. Inflation measures the price of goods and services in the economy. Currently, in South Africa (and globally), we are experiencing high inflation. The SARB has an inflation target range of 3%-6%, and our most recent inflation print was 7.6%, so well above the upper limit of the band. This basically means that goods and services are expensive, which puts pressure on the consumer in terms of their cost of living.
High inflation can negatively impact society as it erodes our purchasing power, which means that our money is worth less - we can’t buy as much as we previously could with the same amount of money. Because of these consequences, the SARB needs to step in to alleviate this pressure, and they do this by raising interest rates.
But where does this inflation come from in the first place? Simply put, when supply and demand get out of balance, it causes inflation. For example, when the supply of a good is limited, the price would naturally increase as supply can no longer meet the demand. We saw this when Russia’s invasion of Ukraine disrupted oil supplies and sent prices soaring. High oil prices feed directly into our fuel costs, which we are all feeling at the moment! Increases in production costs for businesses and a surge in demand for products and services can also cause inflation.
Central banks raise interest rates to curb inflation and try to cool the economy. So how does this affect us? When interest rates are high, borrowing becomes expensive, so people borrow less. Therefore, they have less money to spend, reducing demand for goods and services, and ultimately prompting prices to fall.
The interest rate is basically our “borrowing cost” so we experience the effects of it in many different aspects of our lives. For example, interest rates influence the way we spend and save money. How much would you save if your savings account paid you 3% versus 8%? The average credit card balance in South Africa is R21 200 - would you still spend on your credit card if your interest rate went from 10% to 20%? And would you still take the additional risk of investing in stocks if your savings account was giving you a relatively high return?
We feel rising interest rates on a personal level in the form of home loans, vehicle financing, student loans and credit cards. With the latest 0.75% increase in interest rates that was recently announced, our first worry as homeowners is what our new bond repayment is going to be. For example, a 0.25% hike on average adds R250 to the monthly repayment of a R1 million home loan. It’s easy to see how persistent interest rate hikes over time can start to put pressure on consumers’ budgets.
It's not just the consumer who is affected by high borrowing costs. Businesses’ financial decisions and growth opportunities are also affected. For example, as taking out loans becomes more expensive, companies may be forced to reconsider expanding their operations, ultimately stunting their growth. It may take a bit longer to filter through, but reduced consumer spending also directly and negatively impacts businesses. Reduced demand decreases sales, and as a result, revenue declines. Possible knock-on effects include staff layoffs as businesses cut costs to stay afloat.
In terms of our personal investments, as businesses experience low growth and, as a result, decreased earnings, their share price may be impacted, which can negatively affect the value of our investments. For fixed-income investments, high interest rates are great because we are the receivers of this interest, but rising rates negatively affect the price of the investment. Many scenarios could play out that will ultimately affect our personal investments – all of which highlight the value of having a diversified portfolio that can withstand different economic conditions.
While it may all seem doom and gloom, if the interest rate hikes do what they are supposed to, we should see inflation coming down. This means that our higher cost of living, such as the high fuel and food costs that are putting pressure on our budgets, should start alleviating. In the meantime, consumers can revisit their financial goals and priorities, review their budgets to account for increased expenses and cut back on non-essential spending wherever possible. Most importantly, make sure any decisions you make are well-informed so that you can make the best decisions for your financial future. DM/BM
Author: Natalie Anderson – Investment Specialist at Prescient Investment Management
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