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The Interest Rates Will Remain Where They Are


Image by Jeremy Hynes on Unsplash

Introduction.

If you're an average income earner in South Africa, then you get a gross salary of R25 994 on a monthly basis. Unfortunately, you cannot afford the average home price in South Africa (R1 423 663) with this amount of money; you'd have to earn double that amount to afford the average home price. You can qualify for half the price, though, and the average purchase price for a car is R377 252. Having the average car and the below-average house from November 2021 to today means that you have to pay at least R3 031 more to your monthly interest payments. From November 2022 to today your interest payments would have increased by at least R796. This does not consider other credit products the average income earner may have, such as a personal loan, a credit card, store accounts, and an access facility. The average income earner's cost of living is hit on both sides: the rising cost to service debt and the rising cost of daily living. To illustrate the other side, fuel went up by 34.3% in 2022 and up by another 0.4% in 2023 thus far as an annual percentage change, according to the Monetary Policy October 2023 review. Electricity is up 11.6% and a basket of goods that has meat (10.4%), eggs(24.4%), bread (12.4%) and vegetables (15.6%) are now also more expensive. Therefore, the decision the South African Reserve Bank (SARB) makes to change interest rates is absolutely crucial to the lifestyle of the average income earner.


Prediction: The SARB is keeping interest rates the same.

The SARB's mandate is to protect the currency's value in the interest of balanced and sustainable economic growth. This means that the SARB is purposed to optimise exchange rates, financial, and price stability. The observation of factors that determine the optimisation of these three points (exchange rate, financial and price stability) indicate that interests are to remain the same. It is a matter of debate that the SARB is fulfilling its role to protect the currency's value, given the banks' persistent manipulation of the Rand over the years. What is of less contentious debate is that things are remaining the same.


Price Stability.

With a sole focus on inflation targeting as opposed to a dual mandate such as employment and inflation, as with the US central bank, price stability can be seen as the most important thing for the SARB. This determination to anchor inflation expectations to a given target is governed by the Taylor rule, which prescribes a relatively high interest rate when actual inflation is higher than the inflation target. Headline inflation is trending towards the midpoint of the 3-6% target. However, it is at the upper end of the target at 5.9%. Core inflation remains stubborn around the 5% mark, with the SARB aiming to drop it below the midpoint. It could achieve this by raising interest rates again, but this may compromise financial stability; thus, they can keep interest rates the same and hope for the best. Loading shedding, rising food prices, increasing prices for transport, and the increasing costs of importing goods and services are the leading factors to inflation. The SARB, at best, has very little control over these factors. Thus, it should be noted that inflation can be divided into cost-push inflation and demand-pull inflation. Cost-push inflation is the rising cost of goods and services from load shedding, higher wages, lower exchange rates, higher fuel prices and so forth. Whereas demand pulls, inflation is when there is lots of money chasing fewer and fewer goods. The SARB has the scope to control this side of inflation because it can reduce the amount of loans we get to purchase nice things.


Financial Stability.

"Anyone who lives within their own means suffers from a lack of imagination." Oscar Wilde. Most consumers do not suffer from this lack of imagination; thus, we are quite sensitive to interest changes. Default risk materialises when interest rates are increased for consumers and the private and public sectors. With gross debt at R4.8 trillion in 2023/24 and expected to exceed R6 trillion by 2025/6, debt-service costs as a share of revenue will increase from 20.7% in 2023/24 to 22.1% in 2026/27. The default risk on debt increases for all in South Africa as the debt servicing costs outpace the rate of income. Within the bond market, investors have less appetite for South African debt because compared to prior years when the auction size was 95%, it is now 84.0%. This could be for geopolitical reasons as South Africa is seen to align closely with Russia and other BRICS nations, or it could be investors requiring a greater yield for the risk, which they foresee with such high debt servicing costs. The yield curve for South Africa and other emerging economies is still upward-sloping, unlike the US, which is inverted. This signifies that interest rests are still going to be kept high for the near future for emerging economies and could be expected to drop sooner for the US.


Exchange rate stability.

South Africa relies a lot on money that comes from foreign nationals, this is called foreign direct investment. Therefore, it has to ensure that it remains attractive to keep this money. One way to do this is by adhering to the interest rate parity condition. This condition leads to the SARB following the decisions the US central bank took, as the five-year chart between the fed funds rate and the repo rate is near mirror images. For instance, if the SARB does not maintain parity with the US, investors would take their money from South Africa and go to the US and invest it there because they are getting a higher return for a given level of risk. Thus, Jerome Powell (the chair of the US central bank) has kept interest rates the same in the US, and the governor of the Reserve Bank Lesetja Kganyago, will likely do the same. Over the past 3 months, since the last meeting of the SARB, the US Dollar/Rand exchange rate has remained relatively stable at R18.75 to R19.53 range to the dollar.


Conclusion.

Based on the trend of the lead factors that determine the SARB interest rate decision, it points in the direction of interest rates being kept the same. A decision to reduce interest rates will likely be taken when the economy recedes into a recession. This is likely to manifest in the first or second quarter of 2024. The question is, will it be a hard one or a soft one?



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