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Impact of interest rates on households

31 Jan 2014

John Loos
FNB household and property sector strategist

The Monetary Policy Committee (MPC) of the Reserve Bank (SARB) served up something of a surprise by raising its policy repo interest rate by half a percentage point to 5.5 percent which will in turn cause commercial banks to raise their prime lending rates from 8.5 percent to 9 percent.

The rate hike would further serve to contain household sector credit growth, whose November 2013 year-on-year rate had already slowed to 5.9 percent, from a high of 10.4 percent as at November 2012. We would expect further slowing in this growth in the near term.

The decision appeared largely Rand driven, following sharp currency depreciation in recent times, with key changes to the SARB’s Rand assumptions now causing its CPI inflation forecasts to move outside the target range for an “extended period”.

The decision was in spite of the SARB having lowered its economic growth forecasts for 2014 and 2015.

It appears to be a decision that cannot have been taken lightly, but at the end of the day  the SARB does have an official 3-6 percent inflation target, and must be seen to be responding to severe inflationary pressures should it wish to maintain credibility.

Implications for the household/consumer sector

1. The impact should be seen as “negative” from a short-term consumer point of view.

As the positive impact of the big interest rate cuts has been gradually wearing off through 2012/13, both real household sector disposable income growth and real consumption expenditure growth have been slowing.

By now, we anticipate that these variables’ growth rates are not far from 2 percent, and we anticipate average real consumption growth for 2014 more likely to move down into the 1-2 percent range for 2014.

This would be down from the average growth rate of nearer to 2.5 percent estimated for 2013 as a whole.

2. The rate hike would further serve to contain household sector credit growth, the November 2013 year-on-year rate had already slowed to 5.9 percent, from a high of 10.4 percent as at November 2012. We would expect further slowing in this growth in the near term.

This probably implies further containment of the household sector’s debt-to-disposable income ratio in the near term.

All bets are off regarding any noticeable rise in house price growth compared to recent levels, and single-digit price growth is expected to remain a characteristic through 2014.

This ratio was 75.5 percent as at Q3 2013 representing a decline on the prior quarter’s 75.8 percent and the most recent pace of growth in household sector credit is expected to remain below nominal household disposable income growth of nearer to 7 percent, thus bringing about a further decline in the household debt-to-disposable income ratio in the near term. This would be a positive development in terms of reducing household vulnerability to future interest rate hiking.

3. The rate hike may, however, serve to raise the level of bad debts slightly.

Taking insolvencies as an indicator of bad debt trends, we have already seen a healthy declining trend of recent years virtually coming to an end in recent months, and the rate hike may well once again push insolvencies growth into slightly positive territory.

However, one lone interest rate hike would not have an extreme impact.

4. Finally, a rate hike may have a very slight impact in encouraging household savings although we would not expect “miracles” in this regard, as the savings problem is a longer term structural issue that can’t be solved that easily.

Household savings is very weak by historic standards, with the net savings/disposable income ratio stuck at around zero, implying that what little gross saving exists is just sufficient to cover the depreciation on fixed assets.

Implications for the residential property market

1. For the residential property market, this interest rate hike is seen as a negative for growth in demand, thus likely to have a containing impact on house price growth.

All bets are off regarding any noticeable rise in house price growth compared to recent levels, and single-digit price growth is expected to remain a characteristic through 2014.

2. The new repo rate level, which leaves the prime rate percentage at 9 percent, slightly above house price growth, does not promote unhealthy short-term speculative buying on a large scale, because it is not easy to borrow money at prevailing rates and make quick capital gains.

From a point of view of preventing major speculative activity in the residential market, therefore, this level of interest rates would appear appropriate.