30/08/2024
High interest rates in South Africa have recently made life tough for borrowers and businesses
Many South Africans, especially individual borrowers, and businesses reliant on debt, have struggled with relatively high interest rates in South Africa over the last 2 years. The re-emergence of global inflation after the easing of the COVID lockdowns has pushed South African interest rates up. SA´s prime lending rate went from 7% in October 2021 to 11.75% where it has stayed since May 2023.
High interest rates have been good news for savers and bond investors who are getting higher returns on their cash and fixed-interest investments. However, for borrowers, higher interest payments have squeezed disposable incomes and used up money that could have been used elsewhere.
South African Interest Rates: Where to from here?
The good news for borrowers is that it seems that interest rates may have peaked and that monthly interest payments may be about to fall. Here, we look at how likely that is and what opportunities that may create for investors, individuals, families, and businesses.
Global economic trends play a major influence in South Africa´s interest rate outlook. If interest rates around the world are falling, the SARB might be more inclined to lower rates. The most important global central bank is the Federal Reserve of the United States, which is forecast to start cutting rates at their next meeting in mid-September. The ECB in Europe has already started cutting rates.
The SARB also typically sets rates based on its dual mandate of controlling inflation and supporting economic growth. If inflation falls within the target range and economic growth remains tepid, the SARB may decide to cut rates to stimulate the economy. At present, South African inflation has come down to 4.6% (as at 21 August 2024) which is within the SARB´s target range of 3-6%.
The exchange rate also affects interest rate decisions. If the rand stabilizes or strengthens, the SARB might have more leeway to consider rate cuts. The rand has rallied significantly since the election from R19.50 to R17.85 against the US Dollar (as at 21 August 2024).
Effective reforms and fiscal prudence can create a more favorable environment for cutting rates. A more business-friendly and fiscally prudent government, as seen in the formation of the Government of National Unity (GNU) after the election, has improved these prospects in the eyes of the investment community.
So, it seems likely that the conditions are right for South African interest rates to fall. Great news! What does this mean for you and where are the opportunities?
Lower interest rates tend to stimulate economic activity by making borrowing cheaper for businesses and consumers. This can lead to increased investment, higher consumer spending, and potentially more job creation. For South Africa, this could be beneficial in addressing persistent economic challenges and promoting long-term growth.
Cash: Cash and cash like assets, are generally not used for growing Wealth, and in a low-interest-rate environment, traditional savings accounts and fixed deposits returns are even lower. Longer-term deposits may become more attractive but at the cost of liquidity.
Bonds: Falling interest rates can boost the value of existing bonds. When rates decline, newly issued bonds pay lower interest, making older bonds with higher rates more attractive. Savers can capitalise on this by investing in income funds, which may offer better returns compared to traditional savings accounts.
Equities: Lower interest expenses for companies mean higher earnings and potentially higher stock prices. Investors can look for companies poised to benefit from lower financing costs, particularly those in capital-intensive industries such as utilities or real estate. Banks also benefit from lower rates as it allows them to increase interest margins. As interest rates fall, the present value of future cash flows increases, which can make stocks more attractive compared to bonds. This shift can also lead to rising stock prices and potentially higher returns for equity investors. For income-focused investors, high-quality dividend-paying stocks can offer yields that are often higher than those offered by cash. Investors should look for companies with a strong history of dividend payments and sustainable payout ratios.
Property: Falling interest rates translate to lower mortgage rates. This can reduce the cost of financing property purchases, making real estate investments more attractive. This increased demand can drive up property values, potentially benefiting investors who already own real estate or are looking to sell. Additionally, rising property values can improve rental yields and drive up rents.
Your Retirement Strategy
Perhaps the most important reason to save is to provide for retirement. When interest rates are high, many people cut back on their contributions to retirement products to be able to afford increased debt repayments. This should be a last resort but when rates fall, it is imperative that retirement contributions are increased again to allow for a properly-funded retirement. The opportunities detailed here should further allow for better investment returns to fund this.
If there are further funds left over due to a fall in debt servicing costs, these can also be redeployed into other investments such as Tax-Free Investment Accounts or Voluntary Investments to benefit from the improved investment returns on offer in an environment of lower interest rates.
Falling interest rates, while initially seeming to pose challenges, actually open up a range of opportunities for savvy investors. Understanding these dynamics and adapting strategies accordingly is key to navigating a low-interest-rate environment effectively.
Author: Tunin Roy
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