Interest Rates Remain Unchanged – What does that actually mean?
27 July 2016
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Chris Gibbons: On mobile, on digital, on demand, this is Old Mutual Live, the Money Coach edition, hello and welcome, my name is Chris Gibbons. The Reserve Bank has decided to leave interest rates unchanged. The repo rates stays at 7%, therefore what’s known as the prime overdraft rate stays at 10.5%. What are the implications?
Well, joining me now from Cape Town, Old Mutual Strategist, Izak Odendaal, Izak, welcome, good to have you with us. First off, what were the key factors taken into consideration?
Izak Odendaal: Well, the Reserve Bank targets inflation and therefore the main thing they look at is what is their outlook or their forecast for inflation over the next 2-3 years and in this regard they are seeing that inflation will be slightly lower than they expected previously and I think that was the main consideration for them to stay on hold, but of course they also look at economic growth and the health of the economy and also global conditions and some of the uncertainties that have crept into the global environment and I think that also contributed to a sort of ‘wait and see’ approach to keep rates on hold.
CG: A lot of emphasis, as you say, on external factors, Reserve Bank Governor Lesetja Kganyago referring several times to Brexit causing uncertainty and instability?
IO: Yes, so we need to remember, South Africa is a small economy in the global context and we’re an open economy and particularly our exchange rate is very vulnerable to movements in global sentiments. So the rand reacts to what happens globally and obviously the rand itself is a big driver of inflation. What happened with Brexit and the outcome of the Brexit vote is that the rand weakened on the day quite sharply, but it has recovered substantially since then. Just broadly speaking, what the Brexit vote does is it introduces uncertainty. We don’t know what’s going to happen and in an environment where you don’t know what’s going to happen, Central Banks typically do not raise interest rates, they stand back, they want to see until they have more clarity on what the outcome is going to be.
Did the Reserve bank make the right decision?
CG: So, was it the right decision?
IO: Absolutely. I think with inflation looking like it’s going to trend lower with the rand looking like it could remain at levels that are better than what we saw earlier this year, the oil price has come down a little bit, so all those factors say that inflation is not going to be as bad as we thought earlier in the year and therefore there’s no reason to hike interest rates and given that the economy itself is quite weak and especially consumers are facing a lot of strain, a lot of the factors driving inflation are in fact not under the Reserve Banks direct control, namely the exchange rate and oil prices and so on. I think it was the right decision and I think we will probably remain on hold now for the next couple of meetings.
CG: What then are the implications Izak for ordinary folk?
IO: The good news for ordinary South Africans is that interest rates, if I’m right and they stay at these levels, your cost of borrowing or the cost of repaying debt does not increase any further whereas maybe six months ago there was an expectation that we would see another 1% increase towards the end of the year. Relative to that expectation, at the start of the year I think we’re all in a better position and then perhaps we start looking towards when the first interest rate cut will be sometime next year because as we know, interest rates move in cycles. They don’t ever stay still at one level forever.
Should we be worried about the zero percent growth?
CG: Just as worrying, I guess, a forecast for zero percent growth in the economy, that’s not good news?
IO: That is a first glance that is a very worrying statistic, but basically what it means is that because we had such a bad first quarter and the Governor explained this in a question and answer session after the statement was released, but because you had a 1.2% contraction the first quarter, even if you get positive growth in the second, third and fourth quarters, you will end up at zero percent. Their view is that the economy has bottomed and we are going to see improvement and we already are seeing improvement in the second quarter data and that will probably carry on into the third and fourth quarters, but because the first quarter was so bad, we’re not going to quite catch up yet. Their expectation for next year is growth of just more than 1% and the year thereafter growth of about 1.5%. Those are terrible numbers in and of themselves, but given the weakness that we’ve experienced late last year, this year, that does represent an improvement in terms of economic growth.
CG: You’re listening to Old Mutual Live, the Money Coach edition, on demand, visit dogreatthings.co.za. As we keep an eye on these things, what’s the key thing to watch out for going forward on a day-to-day basis, is it the rand/dollar exchange rate perhaps?
IO: The rand/dollar exchange rate is a crucial factor, as is the global oil price and then the other thing, the big contributor to headline inflation is obviously also food prices and we’ve had a big spike in food inflation and we expect that close to the top in terms of food inflation, we’ll start seeing food inflation drift down towards the end of this year. Those are the drivers of headline inflation, the Reserve Bank also wants to see how consumers and businesses respond to those drivers, so those drivers represent the so-called first round effects. The second round effects is how do we respond to a petrol price increase or how do we respond to imported goods going up because of weak exchange rates and it’s that response that ultimately drives the longer term inflation or the underlying inflation outlook for the economy and that’s actually what the Reserve Bank tries to target. They know that they can’t control the exchange rate or the oil price.
CG: This has been another edition of Old Mutual Live, Money Coach, my name is Chris Gibbons and with me on the line from Cape Town has been Izak Odendaal, Strategist at Old Mutual, Izak, thanks for having been with us. Remember, please feel free to get in touch any time if you have any questions for me or topics you’d like covered on Old Mutual Live Money Coach, please feel free to send them direct to me at email@example.com, I’d be delighted to hear from you, until the next time, thanks for listening, Old Mutual Live, on mobile, on digital, on demand.