What is the interest rate in South Africa
Lets ensure we all understand it and how changes in interest rates affect us.
For the average person the question: what is the interest rate in South Africa is far more complex than for people working in the finance industry. Today we will be studying this question to ensure we all understand it and how changes in interest rates affect us.
So, what is the interest rate in South Africa?
We start by looking at the repurchase rate (repo rate), this is the rate at which the South African reserve bank lends money to the commercial banks of South Africa such as ABSA, FNB etcetera. The banks then add 3.5%, and voila, you have the prime lending rate. This prime lending rate is the rate at which commercial banks in South Africa lend out money to us. For a riskier client, you might have an above-prime loan and low-risk clients might have a below-prime loan. You probably heard around dinner or at an event where people talk about: I got my car financed at prime minus 1 They are referring to this loan.
Today 13 Nov 2022, the repo rate in S.A is 6.25% and the prime lending rate is 9.75% (notice the 3.5% added on the repo rate)
Why does the interest rate go up and down?
South Africa follows a target inflation system where the reserve bank tries to keep inflation within the 3%-6% band. To do this, they change the repo rate which affects the costs of credit for the end consumer. In formal terms, to impress your peers, you can say the SARB monetary policy is to use interest rates to influence the level of inflation.
Let's explain this in more detail, but in the simplest form, interest rate effects are like a see-saw. When interest rates increase, inflation decreases, when interest rates decrease, inflation increases.
When interest rate increases
When the reserve bank thinks the inflation might go outside of the upper band (3%-6%) or it is out of the upper band, it will increase the repo rate. The commercial banks add their 3.5% and it means the end users' prime interest rate increased. This directly affects the cost of credit, such as your house bond amount, your car finance, credit cards, and more. It also increases savings interest-bearing investments, like money market accounts and interest earned at the bank.
These increases in interest create more expensive credit, which makes us borrow less and hence less demand for items. Less demand for items means their prices (inflation) will rise slower or reduce a bit. See how this controls inflation.
Example of interest rate increases on a home loan repayment: If you have an R1m bond and repay over 20 years at a rate of 8.75% your monthly repayment will be R8837. If the interest rate increases by 1% to 9.75% your repayment changes to R9485. You now have R648 less to spend each month, which means less demand for other goods and services and less inflation. The example will be the exact opposite for an interest rate decrease, and you will have R648 to spend which will create inflation.
When interest rate decreases
An interest rate decrease is the exact opposite of the above. When inflation is below or might go below the 3% lower band, the reserve bank will want to stimulate the economy. They do this by lowering the repurchase rate, which lowers interest rates for the end consumer. We then take this cheap money and buy cars, houses and start businesses. This demand drives up prices which creates inflation.
How does inflation affect the economy?
Once people start expecting inflation they know that prices will go up in the future and they spend more currently. Consumer spending drives economic growth which is good for an economy but inflation is only good for an economy if it stays at a mild level and does not have too much inflation.
What we are currently seeing in the world is inflation being exported by the USA. The USA is increasing interest rates, which leads to money worldwide flowing to the USA as a safe haven for their money. This money flows from other countries causing their currencies to weaken against the US Dollar. This effect makes fighting inflation in your local currencies much harder as we all import inflation by buying products based on US Dollars such as oil. Other countries must increase their interest rates to avoid this depreciation in their currencies.
You can see below that most countries this year have depreciated against the US Dollar.
As we are hopefully seeing the end of interest increases from the USA, South Africa should follow suit as our inflation will also be under control. When making big item purchases like a car or house, always keep in mind the future expectations of interest rates as these hikes affect your budget dramatically. If your budget for a given level of interest rate, you might even need to sell the asset as you will no longer be able to afford this asset.
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