Interest Rates and Rand Exchange Rate (The Bugle)

Interest rates have dominated the news since last Thursday 30/1/2014 when the South African Reserve Bank (SARB) announced through its Monetary Policy Committee (MPC) that it was raising is policy repo rate from 5% to 5,5%. This is the interest rate that the SARB lends money to the banking sector, which is always indebted to it. The banking sector by default therefore immediately increase their prime lending rate – within mere hours, by the same amount – prime was increased from 8,5% to 9% on 30 Jan 2014.  It’s only half a percent so why the mild panic? To understand market sentiment you need to have an understanding of where we have come from. On 16 September 2002 interest rates were at a peak of 17% and from there declined to a low of 10,5% by 15 April 2005. The upward cycle started and rates peaked again at 15,5% on 13 June 2008. On 12 Dec 2008 they were decreased to 15% and the downward trend started which bottomed out at our recent 8,5% from 19 Jul 2012. So for 18 months we have enjoyed the lowest rates in 40 years. The increase in rates by the SARB was somewhat of a surprise as most commentators were only predicting the increase to happen towards the end of the year. 

This increase brings to an end the downward cycle in rates and with it the expectation that rates will increase further, and it is this fear of increasing interest rates that has unsettled some. So what changed? The Rand fell out of bed. Our Rand exchange rates to the US$ (11.12), Sterling (R18.28) and Euro (R15) are all at five year highs. Consider the lows within this period: In May 2011 US$ traded at R6.57, in Jan 2011 Sterling traded at 10.32 and in Jan 2011 the Euro traded at R8.85. So a Brit has seen his currency appreciate against the Rand by over 77% in three years. That R16m Zimbali villa has decreased from 1,55m pounds to 875,000 pounds. We should be flooded with South Africans living and working in the UK looking to buy property back home. The impact of a depreciating currency on a small open economy such as South Africa is to significantly increase the risk of inflation. Petrol prices increase almost immediately, which impacts transportation costs, which impacts almost every sector of the economy. So what has driven the depreciation in the Rand and other emerging market currencies? It is the movement of investor funds in the capital markets. Non-resident investors in SA government bonds and equities were large net sellers during the last two months of 2013 – to the tune of R21bn in domestic government bonds and R19.4bn in equities. So why are these investors selling? The decision by the US Federal Reserve Bank to cut back on its quantitative easing programme has created the expectation of a slowdown in China and with that less demand for the raw materials imported by China, much of which comes from emerging markets, with South Africa being one. If investors expect less demand for our exports and therefore a poorer profit performance by those companies that export to China, they sell their investments and repatriate the funds. Strangely enough a recovery in the US and UK economies which allows for the Fed to cut back its quantitative easing is actually bad news for us as an affected emerging market in the short term. A stronger US economy will however be positive news for us in the medium term. The SARB outlook for our economic (GDP) growth for 2014 is 2,8% and for 2015 is 3,3%. The average growth for 2013 is expected to come in at an unimpressive 1,9%.  

So are things going to get better? Yes they are expected to. What about higher interest rates? Well your monthly installment on a typical 20-year bond of R1m increased by R319 as from last Thursday. Another 0,5% increase in rates could be expected and this will add another R324 per month to your installment. As long as you are comfortable with these increases you have nothing to be concerned about.

Published in The Bugle, 5 Feb 2014, Author: Andreas Wassenaar