- South Africa has followed the global example and the Reserve Bank has cut the repo rate drastically.
- The last time that the SARB cut rates drastically was during the 2008 Global Financial Crisis.
- FNB Investment Head Nicholas Riemer looks at how this could impact you as a consumer, saver and investor.
Monetary policy is one of the solutions being utilised by authorities across the world to tackle the economic fall-out of Covid-19. South Africa has followed the global example and the Reserve Bank (SARB) has cut the repo rate drastically.
Lower interest rates can improve the prospects for economic growth during recessions. Theoretically, consumers can borrow more and have lower interest payments and thus buy more, potentially driving economic growth.
The last time that the SARB cut rates drastically was during the 2008 Global Financial Crisis (GFC) and the pandemic is set to bring on a deeper recession than what the GFC brought.
This might well see rates come down even further towards the end of 2020 and stay at lower levels for longer.
What does this mean for me as a consumer?
Repo rate reductions result in lower borrowing costs for you as a consumer. Essentially, this increases your consumer spending capability. Current debt expenses will be cheaper, meaning additional spending capacity each month.
Variable interest rate mortgage bonds will now cost less each month, meaning more funds will be in your account post debit order date.
For consumers looking to purchase a new home, lower interest rates mean lower monthly payments and the possibility of affording more house than previously budgeted for.
Monthly car instalments will also reduce for current debt holders. This might also attract consumers to look at purchasing a new vehicle on the back of the affordable interest rates.
Credit cards, overdrafts and personal loans linked to the variable interest rate will come down in cost, making short term borrowing more affordable.
Considerations:
Consumers must be careful when taking on additional debt based purely on the back of low interest rates. Those fortunate South Africans who have not been adversely impacted by the virus could look to maintain current monthly payments to debt providers to decrease debt balances to pay down debt quicker.
Yes, low interest rates may present a temptation to acquire additional debt, but the low rates have also presented an opportunity for South Africans to reduce amounts owed.
As a consumer you should look to eliminate the most expensive forms of debt first. Store card debt and credit card debt is often more expensive to service and has higher interest rates attached to them. Look to take advantage of interest savings by eliminating all expensive forms of short-term debt. These higher monthly costs can then be saved and invested placing you on a path towards financial independence.
A final consideration is that low interest rates will not last forever. Always budget carefully when looking to acquire a new house or car. Make sure that should rates increase to pre Covid-19 levels that you will still be able to afford the monthly instalments. Increased debt levels mean increased risk regardless of the cost of debt.
What does this mean for me as a saver?
Interest rate reductions will impact you as a long-term saver. Savings and money market accounts linked to the variable interest rate will come down. As a long-term saver, this will impact returns going forward and your goals may need to be reassessed.
Fixed income savings vehicles such as fixed deposits will experience no change in rates if acquired pre Covid-19. This is a fixed interest instrument and the rates offered to you as a saver before rate cuts were made will still be applicable. For savers looking to save through a fixed deposit going forward will see rates offered come down on the back of interest rate reductions.
Considerations:
Conservative savers may need to look beyond general savings and money market accounts to keep their wealth growing at a rate higher than inflation. Savers may need to look elsewhere for yield in the form of lower risk investments as cash only products may mean not achieving long term goals on account of the lower interest returns. For savers in or close to retirement, the rate reductions may result in less income being available outside of capital draw-downs.
What does this mean for me as an investor?
The JSE saw a massive pull back in March and a strong recovery from April through June on the back of the global pandemic. The pull back in asset prices presented some investors with an opportunity to acquire value in the market at discounted prices.
Interest rate cuts to combat the impact of economic downturn has also impacted certain asset classes:
Government bonds: On the back of lower interest rates, government bonds became more attractive to investors on account of the yield offered in comparison to other fixed instruments. Yield and price of this specific instrument have an inverse relationship. The result is a decrease in the bond yield on account of the increased demand for these investment vehicles. Increase in demand increases the price of government bonds and is positive for current bond holders.
Investors looking to acquire bonds going forward will see the price increase and the yield decrease on account of increased demand. The current 10-year bond yield is 9.215% compared to one month ago of 9.335%. Investors and savers have been using government bonds to diversify their portfolios on account of the fixed income nature and attractive yields compared to long term savings vehicles on the back of low interest rates.
Property: Property shares, REITS and physical investment property normally increases in value when interest rates are low. There are two reasons for this. First, property companies and individual investors utilise debt to finance the physical properties. The reduced interest rates will see a reduction in interest expense and as a result improve total rental yield. Higher rental yields result in larger profits made and thus an increase in value. Second, property is valued by discounting future expected distributions to the present by using a “risk free rate” – usually the 10-year government bond yield. As bond yields decline, the value of these companies increases.
Preference shares: Another popular fixed income instrument used by low risk investors to secure consistent returns. The reduction in rates will not be good news for current preference shareholders. Like cash investments, many preference share returns are linked to the prime lending rate. A decrease in the rate results in less dividends received, decreasing the dividend yield as well as the price of the asset. Preference shares however are a nice diversification tool for conservative savers and investors looking for alternatives to long term savings vehicles.
Equity shares: Certain sectors and JSE listed companies will welcome lower interest rates. Lower interest rates will be positive for most companies and will mean lower interest expenses, higher market value of assets as well as increased spending capacity. Consumer facing and retail companies will benefit the most from lower interest rates as the reduction in rates will mean more money in their customers pockets, potentially increasing the demand of products and services.
Listed companies with large amounts of debt on balance sheet will also experience less monthly interest expenses increasing profitability and the potential to reduce these high debt levels. The financial service sector will not welcome lower interest rates as lower interest rates means a reduction in profits. Interest rates are a key driver for banks, as they determine banks’ net interest margins, while life insurance company margins, hedging costs and product sales are impacted negatively when rates are low.
Considerations:
The current environment has meant having to analyse investments very carefully. Although low interest rates are positive for certain sectors, the reason for these rate cuts must always be kept in mind by investors. The economy is struggling because of the virus, and interest rates have been cut to assist both consumers and businesses within South Africa.
Property stocks have pulled back drastically on account of the global pandemic and on paper present an attractive entry point with lower interest rates. However, companies are having to issue rental relief to restaurants, bottle stores, and corporate offices to name a few. Shopping centres are seeing some of their tenants go out of business decreasing rental income and increasing total vacancy in portfolios. So yes, there is certainly value out there in the property sector, but there is also increased risk for investors which must be kept in mind.
When looking at investing in equities, the sectors need to be analysed very carefully during and post Covid-19. The technology sector has boomed internationally on the back of increased demand in lock down, while the luxury sector has seen a reduction in demand on account of the rich being “all dressed up with nowhere to go”.
Yes, lower interest rates are positive for both us as consumers and certain business sectors, but investments must be made with the economic outlook in mind, with careful analysis done in terms of business and asset performance in this new world of ours.
Nicholas Riemer is FNB Investment Education head. Views expressed are his own.
