Interest Rates – What Trends Have in Store for South Africa

The last 6 months have certainly been a very interesting period globally when it comes to interest rates. Most of the Western World has an economic policy of ‘Inflation Targeting,” where there is a single mandate to their country’s Reserve Bank to keep inflation within a band.

The way they control this is to raise interest rates to control growth, and specifically inflation, and then they decrease interest rates to stimulate growth, although they have to control the inflationary factors.

Governments around the world have in the last few years been concerned about rising inflation and have therefore been raising interest rates. In South Africa, we raised interest rates from 10.5% to 15.5% over a 24 month period.

However with the turnaround in the economic prospects globally in the last 6 months, the Reserve Banks around the world have decided to focus on growth to try and revive their economies, deciding deal with inflation later. Also some of the main drivers in inflation have had an impact. Oil has dropped from $145 a barrel in July 08 to roughly $40 now, and world food costs have come down. This has also caused inflation to come down, allowing the Banks to be more aggressive.

Here are some examples:

In Australia, interest rates have dropped from 8.75% to 3.25% over 5 months from since September 08 (a 63% reduction). The USA has decreased from 5.25% (2006) to 0.25%, a 95% reduction. The UK has decreased from 5.75% (July 07) to 1% now, an 82.5% reduction. The ECB from 4.25% (Oct 08) to 2% now, with further cuts expected in March. The National Bank of Switzerland and the Bank of Japan has both already reduced credit costs below 1 percent.

South Africa has been a lot slower in reducing rates, reducing them 0.5% in December and 1% in February, which amounts to a reduction of less than 10%. Tito Mboweni, Governor of the Reserve Bank, indicated that he had tried for a 2% reduction in February, but was declined. This does indicate that South Africa has a good chance of further percentage rate cuts in April, and there’s even talk of them bringing forward the meeting to March. Most economists predict between 3% and 4% drop in interest rates in 2009, taking prime to between 11.5% and 12.5%.

John Loos, FNB property strategist, says this more significant 1% cut is reflective of the poor state of the global economy, which has led to a sharp commodity price decline, and in turn caused the CPIX inflation rate to start declining steadily. "From a peak of 13,6% year-on-year (y/y) in August, CPIX inflation had dropped by 3,3 percentage points to 10,3% by December, and the new re-weighted CPI for January is widely expected to show further significant decline."

The FirstRand expectation is for interest rates to decline to 12% prime in the current cycle, with risks to the forecast more to the downside.

Jacques du Toit, Absa property analyst, says that on the residential property market front, the affordability of housing came under much pressure as a result of a number of interest rate hikes between mid-2006 and mid-2008, declining growth in real household disposable income, the National Credit Act (NCA) and the tightening of banks' credit criteria. "Although interest rates were cut by 150 basis since December last year, causing mortgage repayments to drop by 8,1%, they are still 24,6% higher than in June 2006 when the mortgage rate was at a level of 10,5%.

Nedbank economist Carmen Altenkirch says, “We expect that the Bank may opt to front-load interest rate cuts, opting for more aggressive loosening early in the year followed by more modest easing in the second half.”

Already though, it has an impact on the average South African, with the latest 1% cut in interest rates saving home owners R730 a month on a R1m home loan over a 20-year period, and R365 on a R500k loan over the same period.

In the UK and USA the banks have not passed these decreases onto their clients, crippling the market, however in Australia this reduction in rates for their clients and the stimulus package has revived the market and got the momentum going in the right direction.

In South Africa there are a number of things to consider:

1. Rates are coming down and like the impact that happened from 2001 to 2005 when interest rates dropped dramatically, causing property prices to go up dramatically, it makes sense that in the medium term people understand this potential in the future.
2. Developers are building less stock and so there is going to be an undersupply in the near term of properties, which will cause further pressure on prices and also on rentals.
3. World Cup – in less than 500 days South Africa will be hosting the greatest sporting event on earth. The focus will be on South Africa and it is going to have a big impact on sentiment in the country. From the third quarter of this year the momentum will really start building towards this event.

The question on everyone’s mind is, “When is it the bottom of the market?” However the only time you can call that right is with hindsight. One needs to evaluate every opportunity on merit, understand the fundamentals, the trends and then make a decision.

Should South Africa continue to follow trends, (and the banks pass these reductions on – which they are expected to do) I believe that we will be 6 months behind Australia. I believe there are 6 months to take advantage of the buyer’s market, before the confidence comes back into the market and the pendulum swings the other way. Most importantly, if one makes studious investments with strong rentals and decreasing interest rates, you can find investments which will really make financial sense from an income point of view in the next few months. As Warren Buffet says, “Invest when others are nervous and be nervous when others are investing!”