Interest: you're either paying it or earning it

Have you noticed that your R100 is getting you little less than what it previously did?

Have you noticed that your R100 is getting you little less than what it previously did? Well, thats the pinch. And have you seen your debt repayments start to climb? Thats the punch! Inflation and interest are the two phenomena that underpin this pinch and punch and they have a special relationship in that they work together to create harmony in our economy.

The pinch: Inflation

Inflation is the cost of living, then vs now. Inflation refers to the gradual increase in the price of goods and services over time. Inflation is shown and measured using the CPI consumer price index.  In South Africa, the CPI rate is currently being driven upwards due to high fuel  and rising food costs, amongst others. 

CPI is measured by Stats SA using a basket of goods and services. The prices of these goods and services are recorded periodically and in turn an inflation figure can be calculated.

South Africa updated the basket at the beginning of 2022 to make sure the goods and services are still relevant. Some notable new inclusion in the 2022 basket is gin and cappuccino sachets. Side note: until 2016, rewritable CDs and postage stamps were still included in the basket.

What does inflation mean for me?

Inflation reduces the purchasing power of every rand and cent you own. What you could do with R100, 10 years ago, you probably need R250 for now. This is the effect of inflation. 

As at February 2022, the CPI in South Africa is at 5.7%,  meaning that the price of the weighted basket of goods and services has increased by 5.7% over the period.  It is however important to distinguish between the theoretical CPI number and the actual increased cost of living year on year and even month to month.

As per Stats SA, here are some notable price increases include (Dec 20 -Dec 21):

• Meat: 8.6%
• Wine: 7.8%
• Milk, eggs and cheese: 5.3%

Petrol:

• March 2017: R13.06 per litre
• March 2022: R20.88 per litre

This a a 59% increase over period.

Combatting inflation

Inflation means that your money will lose purchasing power every month, every year. Here are two things to keep in mind when trying to combat inflation:

• Make efforts to work towards an additional income stream which increases yearly in excess of inflation
• When investing, make sure that the vehicle you select offers longer term growth in excess of inflation

The punch: Interest Rates

Anyone whos listened to the radio or scrolled News24 would definitely have heard about it but until I sat in a first year Economics lecture I hadnt fully grasped how its knock on impacts influenced my back pockets in both positive and negative ways.

The prime rate is the basic rate at which banks will charge you on your respective debt agreements such as personal loans, bonds and credit cards. Currently the prime interest rate is 7.75%.

During early 2020, shortly after the start of the hard lockdown, interest rates started to drop to the lowest level it had been in many years, meaning debt was now cheaper. There was a massive push by bond originators, property developers and estate agents, encouraging first time buyers to buy property in light of these low interest rates. At the time, for some, it was cheaper to buy than to rent.

However, the universal law applies: what goes down must come up.

Since then, interest rates have increased by 0.25 basis point per quarter over the past year.

• March 2020: 8.75%
• July 2020: 7%
• March 2022: 7.75%

If you started a new debt agreement such as financing a card or starting bond in July 2020, your monthly repayment would have noticeably increased over the past 12 months. 

What does higher interest rates mean for you

DEBT IMPLICATIONS

• In most cases, the interest rate on your debt is linked to the prime rate.
• As the prime rate increases, so does the interest rate on your debt.
• This means that as rates increase, your monthly repayments on your debt commitments will also increase.
• Be aware of this increasing cost and make sure to adjust your budget accordingly.

SAVINGS + INVESTMENTS

• The current best interest cash rate is at 4.25%  this is more or less the type of return you can expect to receive on savings in your bank account.
• One year ago, the cash interest rate was at 3.5%.
• Currently inflation is at 5.7%. This is higher than the rate you are receiving on savings in a bank account.
• It is so important to be aware of this and not depend on bank savings for longer term growth on your money.
• Theoretically, your money is losing value every year in which it grows at a rate lower than inflation.

The relationship between inflation and interest rates

Here comes the Economics lecture! Theoretically, interest rates and inflation have an inverse relationship  as the one goes up, the other comes down.

As inflation starts to creep upwards, the SA Reserve Bank (SARB) uses interest rates to control inflation.

In South Africa, the expectation is that the SARB will continue to implement gradual interest rate increases of 0.25% per quarter over 2022 and 2023.

THAT MEANS Over the next two years there is a looming 2% increase in interest rates.

On the one hand, our debt is going to become a lot more expensive and it is important that we make provision for this in our monthly budget. On the other, more positive hand, our savings and investments are going to grow at a greater rate.Youll find this double whammy often when navigating your personal finances. Just because something has a negative impact does not mean its only bad. This is exactly how interest rates work  youre either paying interest or earning it!