Traditionally, South Africans have been accustomed to relatively high inflation and relatively high interest rates, but they’ve had it easy over the past few years.
The recent spate of sharp interest rate hikes by the South African Reserve Bank (SARB) were off the low base established at the beginning of the Covid-19 pandemic in 2020.
In July 2020, in an effort to stimulate the lockdown-stricken economy, and in line with emergency measures taken by other central banks, the SARB reduced the repo rate to 3.5%, the lowest in South Africa in living memory. Rates stayed at this level for 16 months, during the worst of the pandemic. At the end of 2021 they started creeping up tentatively. Then, in the middle of last year, the SARB began raising rates aggressively as inflation, which had been mysteriously absent from global markets for years, made a comeback.
The “blunt instrument” of hiking rates, which central banks use to tame inflation, may be crude but has proved relatively effective. The SARB has been successful for the most part in keeping inflation within its 3-6% target range since it formally introduced this practice in 2000. The trouble, of course, is that it’s a delicate balancing act, because if either inflation gets too high or interest rates rise too sharply, the economy suffers.
There’s an interesting economic experiment currently under way, and it goes by the name of Türkiye. The country’s newly re-elected President Recep Tayyip Erdoğan has bucked the advice of the world’s leading economists and kept interest rates low in the face of rising inflation. It may still be too early to tell how the experiment will pan out, but things are not looking pretty. According to a “Financial Times” report, Türkiye is burning through its gold and foreign currency reserves to try to prop up its currency, the lira, which has lost 20% of its value in a year, and inflation is running at a frightening 40%.
Let’s look at how consumers are affected under the two scenarios
Raising interest rates to curb inflation: This is a great environment for people saving in lower-risk investments and for retirees living off savings in interest-bearing instruments. It means higher returns without the buying power of one’s money being eroded too quickly. But it’s bad for people with debt, who face higher repayments, and it’s bad for entrepreneurs needing to borrow money to start a business. Stock markets tend to be volatile during these times because lower-risk investments such as bonds and cash become more attractive for investors.
Keeping interest rates low while inflation rises: This is terrible for savers in interest-bearing accounts and for retirees living off an interest-related income: the returns can’t keep pace with inflation, so one can buy less and less with one’s money. Low interest rates are good for borrowers, because their debt repayments stay low. But unless their wages or salaries keep pace with the rising inflation, which is not guaranteed, other household expenses will eat into their income. Equities (shares) are generally regarded as a hedge for investors against high inflation, and would be the preferable investment in this scenario, but depending on what is causing the inflation, stock markets may also come under pressure.
Tough times for homeowners
While interest rates on all types of debt have risen substantially over the past 18 months, holders of mortgage bonds are suffering most because the repayments typically make up a large portion of a household’s monthly expenses.
If you bought property in mid-2020, when interest rates were at their lowest, depending on your rate and the term of your bond, your bond repayments are likely to have risen by around 37%. The table indicates how the repayments have increased on a bond taken out in July 2020.
Corné Welman, franchise principal and Certified Financial Planner at Consult by Momentum, says the silver lining is that if you’re considering buying a house and can comfortably afford the repayments, now is actually a great time to do so.
“The rates will drop soon, leaving you with more disposable income. If you’re really clever, you would keep your bond repayments the same as what you’d pay at the peak of the interest rate cycle, which would allow you to pay off your home a lot quicker.”
He adds that when buying a house, make sure that there’s enough buffer in your budget to provide for possible interest rate hikes.
And if you bought property a while ago and are battling with the repayments?
“Talk to your financial adviser, who can help you restructure your budget, discuss the options available to you, and help you make those difficult decisions that will allow you to ride out the storm until things get better,” Welman says.
Hesse is the former editor of Personal Finance.
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