Saving takes priority after interest cycle turns

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This is an eventful week for South African macroeconomics, and for the Reserve Bank especially. But why should that be important to you? Because macroeconomics doesn’t happen without microeconomics, and you are the micro.

The two big events this week are the publication of the April inflation statistics yesterday, and the announcement of interest rate changes by the monetary policy committee (MPC) today. The two are intricately related.

Every couple of months the MPC meets to decide whether the repo rate should increase, decrease or remain unchanged. Today, most economists and analysts expect it to remain the same. The repo rate is the interest rate that the commercial banks pay on loans that they are obliged to take from the Reserve Bank. When the repo rate changes, the prime rate – the base rate that the commercial banks charge you – almost always changes by the same magnitude.

Changes in the repo rate also cause an adjustment on other debt and investment-related rates throughout the economy.

The repo rate is the leash the Reserve Bank uses to guide the economy, and the pet on the end is inflation. The Reserve Bank’s objective – one that is enshrined in the constitution – is to maintain price stability in the economy. By tightening (increasing) or loosening (decreasing) the leash (interest rates), they are able to cause a multitude of impacts on all levels of the economy.

Most directly, the repo rate controls how expensive it is to borrow money and, therefore, controls how much spending is taking place in the economy. Higher interest rates mean that more of your disposable income is being used for interest payments; that spending on credit is more expensive; and that saving your money in interest-bearing accounts is more attractive.

All these together result in less spending on goods and services each month. The lower demand on businesses and their inventory means the pressure on prices decreases and inflation slows down.

From a supply side, rising interest rates attract the attention of the global money market and investors see South Africa as a more attractive place to invest in interest-bearing portfolio assets. The inflow of foreign currency increases the demand for the rand and causes it to appreciate.

Given South Africa’s immense oil imports and its dependence on imported inputs for production, a stronger rand decreases the cost of production and transport, and lowers pressure on retail prices.

In this way the Reserve Bank casts its grip on the economy – sometimes its tools are strong enough to counter the force of other factors pushing at economic growth and inflation, other times these are blunt and comparable to pushing a piece of string.

This is the balance MPC members try to get right every time they meet. If they keep interest rates too low, inflation might run amok, but if they raise them too high the economic pulse of borrowing, spending and investment might slow to stagnancy.

If interest rates are not increased today, the Reserve Bank has stated that it was almost certain that rates would rise over the next few months. This is due to domestic inflationary pressures and in line with movements in foreign economies.

Given that this single announcement can change what’s happening in your wallet, it is advisable to start moving away from debt and spending on credit, and to start putting your money in places where it can ride a wave of earning when rates rise.

Pierre Heistein is the convener of UCT’s Applied Economics for Smart Decision Making course. Follow him on Twitter @PierreHeistein


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