An increase in interest rates is generally negative for equity stocks and “there are not many places for investors to hide when inflation is on the rise”, according to FNB.
The comment comes in the wake of the Monetary Policy Committee (MPC) deciding to increase the repo rate by another 75 basis points (bps).
The increase will see the repo rate increase to 5.5 percent per year. The decision was made on the back of the South African inflation rate surging above the central bank’s target range. The increase of interest rates is a key monetary policy tool used by the South African Reserve Bank (Sarb) to manage inflation.
The Sarb last week increased the repo rate in a bid to curb supply-drive inflation and the depreciating rand – the biggest hike in borrowing costs in almost two decades, which shocked markets.
Bheki Mkhize, CEO Wealth and Investments Solutions at FNB South Africa, said: “Higher interest expenses, lower market value of assets as well as a decrease in consumer spending capacity results in negativity for certain sectors in the market.”
The current 75 bps hike would have the following impact on asset classes, according to FNB:
Retail and consumer facing shares would least welcome the news of a rate increase. Higher interest rates impact consumer spending with a reduction in borrowing capacity. Consumers borrowing less, would result in consumers spending less impacting retail and consumer facing company share prices negatively.
Companies with high debt levels would experience an immediate increase in borrowing expenditure, on account of higher interest expenses on account of a higher variable interest rate. This would have an impact on cash flow of these companies potentially impacting the share price negatively.
Banks and insurers would be positively impacted by interest rate increases. For both industries interest rates were a key driver for margins and an increase in the rate would result in positive economic sentiment.
Consumer stocks would be impacted on account of higher interest rates and inflation. Local investors should keep in mind how the reduction in consumer spending capacity would impact the listed retail sector, FNB said. There were certain oil companies that will benefit from rising oil prices. Higher oil prices result in higher profits for oil companies.
Mkhize said, “Higher interest rates are also generally negative for the bond market, but positive for cash (although higher inflation may still see negative real returns on cash instruments).
“Ultimately, there are not many places for investors to hide when inflation is on the rise, however diversification through the incorporation of different asset classes within a portfolio is still the best strategy for investors,“ Mkhize said.
Himal Parbhoo, the CEO FNB Retail Cash Investments, said, “Savings instruments linked to the prime lending rate will experience an increase in the interest earned on account of a higher variable interest rate.
“There will be no immediate change to those savers with fixed savings instruments. However, those savers looking to use fixed savings instruments post July 21 will see an increase in the rates offered by financial institutions.”
A higher repo rate results in higher income in the form of regular interest payments, which is particularly useful during bouts of market volatility. The recent increase in rates will see cash instruments becoming more attractive to South African investors and savers.
FNB said bond holders would not welcome an increase in the repo rate.
Typically, an increase in the interest rate results in local bonds becoming less attractive to investors, due to higher interest rates offered in cash related instruments. This results in an increase in bond yields and a decrease in bond prices impacting bond holders negatively.
Like cash investments, preference shareholders would see the increase in rates as good news. Most preference share investments are linked to the prime lending rate, thus an increase in the rate results in higher dividends received, increasing the dividend yield as well as the market value of the asset class.
Rising interest rates and inflation will have the following impact on South African consumers as well as investors:
The impact on SA consumers:
Rising interest rates mean rising borrowing costs for South African consumers, decreasing their spending capacity.
Parbhoo said: “SA companies utilising debt to conduct business are going to incur higher operating costs as a result, and these are typically passed on to the consumer, meaning a higher cost of goods for SA consumers. Inflation also has a negative impact on SA consumers.
“The increase in the fuel price is a large contributor to the rising inflation levels. Higher fuel costs mean higher vehicle running costs for consumers, but also means consumer goods increase in price on account of larger logistics expense. As a result of rising inflation and interest rates, SA consumers are ultimately going to pay more for a basket of goods,” he said.
FNB said consumers must be wise in the types of debt utilised. During times of increasing interest rates, short-term debt facilities should be used the least.
Credit card and short-term overdrafts are very expensive forms of debt and are typically linked to the variable interest rate. Consumers must be careful not to increase debt levels during times of increasing interest rates and live within their means. Long-term debt facilities will have the lowest cost to consumers and if possible, SA consumers should look to eliminate short-term debt with further interest rate increases expected, the bank said.
Looking ahead, FNB warns that the Sarb looks set to continue to increase interest rates in order to manage inflation, and South Africans should expect further rate increases as the year progresses.
Jeffrey Schultz, the senior economist at BNP Paribas South Africa, said last week that he put a base case of a 75 basis points hike for September, but said the door was open for a larger 100 basis points hike should inflation continue to rise
The Sarb expects inflation to remain above the upper limit of its target range of 3-6 percent until the second quarter of 2023, and only revert back to mid-point by the fourth quarter of 2024.