Impact of Recent Reserve Bank Interest Rate Changes

‍Repo rate: 8.00%

Prime interest rate: 11.50%

Effective from 20 September 2024

In September 2024, the South African Reserve Bank (SARB) cut interest rates by 25 basis points saying that it continued to see a dip in headline inflation in the near term, supported by a stronger rand. The reduction, the first one of more than four years, leaves the benchmark repo rate at 8%.

And for most, this is welcome news. With reduced interest rates, South African consumers can expect lower repayments on home loans, credit cards and other debt, while new homeowners can expect monthly payments to drop.

The decision came a day after data from Statistics South Africa, which showed that inflation eased for the third consecutive month to 4.4% year-on-year in August from 4.6% in July, reaching its lowest level since April 2021. This is below the midpoint of the Reserve Bank’s 3-6% target band.

A statement by SARB’s Monetary Policy Committee was as follows –

“As we move towards the end of the year, global inflation is slowing and nearing targets. Given these gains, major central banks have lowered rates. We saw the European Central Bank cut again last week, the Bank of England eased in August, and the US Federal Reserve reduced rates last night. The US dollar has also cooled off in recent months, providing some respite for other currencies, including the rand.

Despite these welcome developments, central banks are moving carefully, and policy stances remain relatively tight. Economic activity in major economies has been resilient, even as inflation eases. Underlying measures of inflation have also fallen less than headline, primarily because of elevated housing inflation, and robust wage growth.

The case for caution is further bolstered by the difficult and unpredictable geopolitical environment, with risks of inflationary shocks through trade restrictions and supply chain disruptions, among other factors.

Overall, global conditions have become more favourable, but there are still risks. A ‘soft landing’ is looking more likely, after the worst inflation surge in a generation, but it is not inevitable. The financial market volatility of early August was a reminder of the fragilities and uncertainties in the system.

For these reasons, central banks are approaching the endgame with caution.”

And while a “better safe than sorry” approach sounds like a good thing, especially to those with debt, a little help in understanding what all this means is important. Having a good understanding can not only help you make better-informed decisions about your finances but can also help you maximise the returns on your investments.

So, let’s take a closer look at some of the main points that you should consider when it comes to rising or decreasing interest rates, your money, and your investments.

How SARB uses interest rates

Interest rates typically work in cycles and are used as a mechanism for SARB to control inflation (the rate at which the cost of goods and services increases) over time. To ensure that inflation remains within SARB’s target range of between 3 - 6% per annum, SARB either decreases or increases interest rates to support or moderate economic activity, which in turn has a direct impact on consumer spending, and consequently inflation.

When the repo rate increases, the following happens:

1. Interest rates on your home or car loans will increase, which in turn will increase the monthly repayments.
2. Interest rates on your savings or investments will also change. Banks may offer higher interest rates for saving money, which is an advantage if you have extra money to save.

When the repo rate decreases, the opposite happens:

1. Interest rates on your home or car loans will decrease, which in turn will decrease the monthly repayments. 
2. Interest rates on your savings or investments will also change. Banks may offer lower interest rates for saving money.

Let’s break these components down a little more –

While the above explains the macro view, perhaps a little more explanation is necessary. The purpose of SARB (and in order for it to fulfil its constitutional mandate) is to protect the value of the rand by keeping inflation low and steady. It does this by means of a monetary policy.

• The monetary policy is the means by which central banks like SARB manage the money supply within a country to achieve their goals. SARB then uses interest rates to influence the level of inflation.
• The basic aim of a monetary policy is to determine how much money an economy should have in circulation. The monetary policy is implemented by setting a short-term policy rate – known as the repo rate. This affects the borrowing costs of the financial sector, which, in turn, affects the broader economy. It’s called the repo rate because banks give SARB an asset, such as a government bond, in exchange for cash. They can later repurchase (repo) that asset at a lower price, which reflects the interest they paid (i.e. the repo rate) to have the cash.
• The National Treasury, in consultation with SARB, sets the inflation target, which acts as a benchmark against which price stability is measured. The SARB then independently makes the monetary policy so as to achieve this target – here the aim is to maintain consumer price inflation between 3% and 6%. The value of the currency is therefore protected relative to domestic consumer prices.

What is inflation and how does it affect the economy?

According to SARB, inflationis an increase in the general price level of an economy. It involves more than price shocks like higher petrol prices. In most economies prices are generally higher than they were the year before i.e. they are inflating all the time. For instance, in South Africa, consumer prices rose by 65% between 2010 and 2020, at an average annual inflation rate of 5.2%.

In South Africa, the standard measure of inflation is Statistics South Africa’s (Stats SA’s) consumer price index (CPI). This index represents a typical basket of goods and services used by South African households, comprising everything from lottery tickets and petrol to life insurance.

There are three basic causes of inflation – supply, demand, and expectations –

1. Supply-side inflation – inflation tends to decrease if it becomes cheaper to produce a good or service i.e. manufacturing of clothes and goods became cheaper as the world became more globalised.
2. Demand-side inflation – when consumers spend more money, prices tend to rise faster. By contrast, when consumers are under pressure and spend less, prices rise more slowly. 
3. Expectations - this is the most abstract cause of inflation, but also the most important, especially for central banks. All countries experience supply and demand shocks, but different countries tend to have markedly different inflation rates. The reason for this is expectations. What is the expectation here?

What then are interest rates?

Interest rates refer to the cost of borrowing money or the return you earn on your savings (ROI). SARB determines the benchmark repurchase rate (repo rate), which directly affects the interest rates that commercial banks, charge for loans and offer for savings. The repo rate therefore directly affects the interest rates.

In summary -

When SARB raises interest rates, borrowing becomes more expensive, and saving becomes more attractive. When rates are lowered, borrowing costs decrease, encouraging spending and investment, while the returns on savings diminish.

How has the recent change in repo rate affected the South African Economy?

The impact on businesses

Lowering the interest rate puts more money back into the economy. It does this by putting cash back into businesses, thereby encouraging them to invest in their own expansion, in development of new projects and hiring of additional staff, thus contributing to improved foreign business confidence levels which could, in turn, benefit the South African economy as a whole due to foreign investment.

The cost to borrow funds also decreases enabling SMEs (small to medium enterprises) to borrow money, or access additional funds, to expand or start new projects at a lower cost. This, in turn, has a positive impact on the economy as it stimulates growth (often at grass roots levels).

The impact on individuals

A decrease in interest rates also has a direct impact on the disposable income of consumers, allowing them to spend more, which is always positive for small businesses. If the right strategies are implemented at the correct time, businesses can improve their cash flow and increase their profits in the long term.

As far as individuals are concerned it’s good news for any debt they have because when interest rates decrease, loan and bond repayments become cheaper. This is because the rate at which the interest component of the loan is calculated decreases. This is good news for anyone with high levels of debt. It may be a good idea, while interest rates are low, to settle debts where the interest is variable.

Essentially you have two types of interest rates where loan and bond repayments are concerned –

1. Variable interest rate - changes with the prime rate. When the prime rate is increased, the interest rate on your loans will also change and your repayment amount will increase and vice versa.
2. Fixed interest rate – doesn’t change during an agreed period. When you borrow money on a fixed interest rate, the rate stays the same throughout this period and your monthly payments stay the same. It offers stability and protection against interest rate hikes and is commonly used in car repayments and home loans. The best time to choose a fixed interest rate is when interest rates are low, and you believe they will increase.

The impact on investments

• Cash investments include savings accounts, fixed deposits, and money market funds that provide regular interest payments and are considered lower risk. Lower interest rates reduce the attractiveness of fixed-income investments, prompting investors to look for higher returns in other asset classes. This can lead to outflows from these investments.
• Bonds are debt securities issued by governments or corporations. They pay periodic interest and return the principal at maturity. Existing bonds with higher interest rates become more valuable when rates drop. New bonds will have lower yields, prompting some investors to seek higher returns elsewhere.
• Equities, or shares, represent ownership in a company and a claim on part of the company's profits. Interest rate changes can significantly impact equity markets. Lower borrowing costs can boost a company's profits and encourage business expansion, leading to higher share prices. Lower interest rates also make equities more attractive compared to bonds and other fixed-income investments, as they offer higher potential returns.
• Real estate includes residential, commercial, and industrial properties. Interest rates impact real estate through mortgage rates and the cost of financing property purchases. Lower mortgage costs make buying property more affordable, increasing demand and driving up property values and rental income. Lower financing costs encourage property development and investment, leading to potentially higher returns.

In the Mail & Guardian they stated that should there be another 25 basis point rate cut in November in addition to the one in September, it would take the repo rate to 7.75% by the end of 2024. At this stage, a further 75 basis point reduction in 2025 is possible. And that friends, as we have learnt, means more money in our collective back pockets.

A further reduction will boost consumer confidence and lift the economy. Something South Africa desperately needs. And with the Monetary Policy Committee set to make the announcement in the next week or so, we can only sit and wait with bated breath.

Although we have taken the utmost care to ensure that this information is correct, we urge you to consult with a suitably qualified legal practitioner who will be able to answer any questions you may have on how a change in interest rate may influence contract negotiations or terms of a contract. In this regard, wewould be more than happy to assist you. Please feel free to contact us to see how we can best assist.

We are a law firm that considers honesty to be core to our business. We are a law firm that will provide you with clear advice and smart strategies - always keeping your best interests at heart!

(Sources used and to whom we give thanks – South African Reserve Bank here and here; Mail & Guardian here and here; Nedbank; FNB; Moonstone; M&G Investments and British Business Bank).