Expect more interest rate hikes

Published Feb 2, 2014

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The impact of this week’s 0.5 percentage point (50 basis points) increase in the repo rate will depend on whether you are a borrower or a lender. Nearly all borrowing and lending interest rates are based on the repo rate.

Although the Reserve Bank’s decision took many commentators by surprise, they are now saying that interest rates, after being at record lows, are set to increase by another two or more percentage points this year. If their prediction is correct, borrowers will have to factor in the possibility of paying even higher rates, particularly when they borrow large amounts, such as for a home loan, where an increase of even a few percentage points can mean paying hundreds, if not thousands, of rands more.

Paul Stewart, head of asset management at Grindrod Asset Management, says this week’s rate hike will not have a significant impact on the economy, although the millions of consumers who are highly indebted will be negatively affected.

However, if there is another hike of 0.5 to one percentage point in the next three months, the pressure on consumers will begin to mount, Stewart says.

If you have a home loan of R500 000 and your bank charges you the prime rate, your instalments will rise by R159 a month. But if the prime rate increases a further percentage point, to 10 percent, your monthly instalment will be R486 more than you’re paying now.

Neville Chester, senior portfolio manager at Coronation Fund Managers, says the increase is good news for pensioners and people living on a fixed income.

With the shift up in the yield curve, the forward interest rate market is pricing for positive real yields by the end of the year (returns will exceed the rate of inflation).

Chester says the sell-off in the equity market this week, which saw the FTSE/JSE All Share Index drop by 1 500 from a record 47 000 a week earlier, “is most likely an over-reaction, but something which we have predicted for some time, in that when foreigners start selling, the exit door will be very narrow, as they all try to sell at the same time”.

Investors are concerned that already-under-pressure consumers will be placed in more difficulties, with rising interest rates eroding company profits, he says.

The reaction of the equity and bond markets to the rate increase implies that there will be a further increase of at least two percentage points this year, Chester says. To the extent that this does not happen, there is most likely to be an upside in equities and bonds.

André Roux, Investec Asset Management’s co-head of emerging market fixed income, says the rate increase is not good news for consumers and consumer-related activities, such as retailing.

“It will slow down consumption and investment demand. However, it will help to reduce the demand for imports,” he says.

The main effect of the increase – and any future increases – is that it will push up home loan costs and, as such, is a setback for the property market. This is a pity, Roux says, because the housing market was just starting to show the first signs of picking up since the 2008 crash.

John Loos, household and property strategist at First National Bank Home Loans, says the interest rate increase will discourage first- time property buyers from entering the market, while putting pressure on those – such as pensioners – who need to downsize to save money, to sell earlier than they otherwise would have. The rate hike could therefore result in a stronger demand for rental property.

However, if rate hikes go far enough, they will dampen the demand for rental accommodation, because tenants have their financial limits and often have debt, he says.

“But in the initial stages of the interest rate-hiking cycle, we would expect rental inflation to be positively correlated to interest rates, and anticipate some acceleration in rental inflation to feed through into inflation, thereby posing some additional upside risk to interest rates,” Loos says.

SOUTH AFRICA IS ONE OF THE ‘FRAGILE FIVE’

Correcting imbalances in the economy to enable South Africa to grow on a more sustainable basis is the reason behind the 0.5 percentage point increase in the repo rate this week, André Roux, Investec Asset Management’s co-head of emerging market fixed income, says.

“The country is at the start of a tightening cycle. The bond market has already re-priced – it has now priced in rate increases of 200 basis points (two percentage points) by September. The long end of the bond market has also priced in this scenario,” Roux says.

South Africa is not alone in facing interest rate increases.

Neville Chester, senior portfolio manager at Coronation Fund Managers, says that last year bankers Morgan Stanley coined the term “fragile five” to describe South Africa, Brazil, India, Turkey and Indonesia.

“What these countries have in common are large deficits, slow economic growth and open capital markets with a large foreign portfolio investment.” These characteristics make the “fragile five” particularly vulnerable to tighter monetary policy in the developed world, mainly the reduction in the economic stimulus packages by the United States Federal Reserve, Chester says.

The other four countries that comprise the “fragile five” hiked their rates before we did on Wednesday.

Paul Stewart, head of asset management at Grindrod Asset Management, says the Reserve Bank was forced to follow the other four.

“It had to be seen to be doing something instead of standing by and watching the train wreck. In many of these emerging markets, a significant proportion of their bond debt is issued in US dollars and the euro, so currency depreciation implies much higher interest costs to the fiscus, and the rates hikes are an attempt to stem the capital outflow.”

However, Stewart says the bulk of South Africa’s debt is denominated in rands, so “perhaps the Reserve Bank did have some wriggle room, which it decided not to use”.

Chester says that investors are uncertain how significant the mini-crisis in emerging markets may become, with the result that volatility will increase in the short term.

Roux says the rand’s reaction immediately after the interest rate increase “is somewhat perplexing and, from a policymaker’s perspective, a bit disappointing”. One would expect the increase to help reduce the imbalances in the economy and hence to support the rand, he says.

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