INTEREST RATES

INTEREST RATES

Global interest rates are so topical these days. In a world where the stock markets react to R-factor news, especially second-waves, stimulus packages and seemingly ignore joblessness and the general economy, interest rates play a huge part.

Traditionally, Reserve Banks, apart from their general economic well-being mandate, are established to determine the interest rate and stabilize the currency. Their primary tools are the Repo rate, sales and purchases of instruments, and printing of money. The latter, apart from the clean-up of old/broken notes and coins, is primarily monitored by the ebb and flow of money supply, the so-called M1,2,3 supply of money. Of course, all of this is supposed to be without political interference, but it’s very hard to keep the politicians out, especially when they want to own the Reserve Bank.

Allied to all of this is two things:

  • The banks’ Prime rate, their supposed lending to their best clients, is priced off the back of the Repo rate. 3% above, is generally the norm, however, currently the Repo is 3.5% and Prime, 7%. Just fyi, the USA Federal Reserve rates are: Federal Discount rate: 0.25% [2.75%] and Prime: 3.35% [5.25%]. The FED is resisting 0% or negative interest rates at present as part of the overall stimulus of the economy. 
  • Inflation. A measure of the rate of increase or decline in the cost of goods and services, inflation for us has been most severe in Food and Services. If Eskom increases 15% next time, this would be a blow, for instance. Inflation is benign at present, reducing from 4.62% in 2018, to 4.3% in 2019 and then falling to 2.3% at end-February 2020. 
  • Real interest rate. The difference between Prime [or any interest rate at which you borrow, really] and Inflation is the Real interest rate. Right now, 7 – 2.3 = 4.7%.

COVID has changed the rules sharply and if you had any sense that rates will remain this low for the long-term, then you need to look at the Bond yields. Bonds are sold by the government in order to fund the borrowing needs of a country. The short-term bonds i.e. R2023 is 4.455%, but the long-term bonds, R2032 and R2048 are 10.190% and 11.510%, respectively. Intuitively, we probably feel that interest rates will rise over time, but the real issue here is the risk. South Africa has to attract Bond investments from risk-aware investors. To do this, we have some of the highest-priced Bonds in the world. My guess would be that if we reversed our Junk status and grew our economy, we could have the long-term bond yields halve over time.

So, the question may be: What are interest rates? An interest rate is the price you pay for money borrowed and the price you receive for money invested. Those of us borrowing are happy when interest rates go down and those of us investing, like them up. Talk about money “going round”! Economically, interest rates can be seen as the value, or cost, of money over time. When the banks need it, they pay more for deposits and then need to charge more for borrowing and vice versa.

The SARB sets the scene with the Repo rate, in other words, the rate at which the banks could borrow from the Reserve Bank “at the window” if they needed liquidity. But the banks also have another standby rate which has become institutionalised, the Johannesburg Inter Bank Acceptance Rate or JIBAR. JIBAR, 3.68% today, is about 2.5% below Prime and, as the name implies, the banks lend to each other real-time. When I use the term “institutionalized”, it simply means that the rate has become a benchmark underpin for several corporate lending transactions in the country.

Finally, the rub of all of this. The Reserve Banks worldwide dislike inflation and control it primarily by adjusting interest rates. Too much inflation probably means that consumers have too much money, including borrowed money unfortunately, and are demanding [“chasing”] too few goods. Avocado Pears are a good example. Sometimes R20 each and other times, R20 for 4. Simplistically, their inflation is driven by local production and our willingness to pay. Inflation at the levels we are currently enjoying is as a result of little demand caused by an economy in depression and unemployment, both factors probably at historic levels. The Oil price is also a good dipstick of this condition globally.

Abruptly perhaps, I’m ending here. Enough interest rate economics for today but with Part 2 to follow…

Yours in Property.

Jack Trevena

Jack Trevena

With over 30 years of experience in the banking and home loan industry, my hope it is share what I have learnt over the years with my blogging community, inspire conversation around the subject and in the process discover unique insights into this ever changing environment.
Jack Trevena

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