The South African Reserve Bank (SARB) on Thursday increased the cost of borrowing by 75 basis points (bp) to 5.5%, the biggest increase in nearly 20 years as the central bank seeks to contain the surging domestic inflation.
On Wednesday, data from Statistics South Africa showed that annual consumer price inflation (CPI) rose to 7.4% in June, from 6.5% in May. It was the highest reading since May 2009.
This week’s interest rate increase was also the fifth consecutive rate hike since November last year. And more alarming is that experts expect more increases in the coming months.
Jeff Schultz, senior economist at BNP Paribas South Africa, said he expects another 75bp hike when the central bank’s monetary policy committee meets in two months’ time.
“Another 75bp hike remains our base case for September…its (SARB’s) latest communication, we believe, clearly opens the door for a larger 100bp hike at its next scheduled meeting should CPI continue to surprise to the upside (which we believe remains a real risk in the near term relative to its still quite conservative quarterly CPI estimates given),” he said.
With inflation surging at rates not seen in decades, many consumers are wondering how to keep rising prices from negatively affecting their savings and spending habits.
“Consumers with larger loans that are repaid over longer periods of time will see bigger increases in their loan repayments,” explained Steven Barker, head of everyday banking and cash lending at Standard Bank.
“The increased repayment will have a negative impact on household budgets, as the additional expense needs to be catered for and could lead to cutbacks in other expenditure. In an increasing interest rate environment, we expect to see consumers being more careful and considerate when taking out large loans, like home loans.
“Ask yourself if the loan for a [desired] purchase to be made can be deferred and can rather be made through savings, meaning that a smaller loan will be required,” Barker advised. In this lending climate, he suggests considering the following before taking out a loan of any nature:
- Leave some affordability in the monthly budget to cater for some further increases in interest rates;
- Don’t only focus on the monthly repayment of the loan, but also understand what the total cost of the loan is; and
- Try reducing the length of the repayment.
How interest rates affect spending
According to Investopedia, with every loan, there is some probability that the borrower will not repay the money. To compensate lenders for that risk, there must be a reward: interest.
Interest is the amount of money that lenders earn when they make a loan that the borrower repays, and the interest rate is the percentage of the loan amount that the lender charges to lend money.
The existence of interest allows borrowers to spend money immediately. The lower the interest rate, the more willing people are to borrow money to make big purchases.
When consumers pay less in interest, this gives them more money to spend, which can create a ripple effect of increased spending throughout the economy. Businesses and farmers also benefit from lower interest rates, as it encourages them to make large equipment purchases due to the low cost of borrowing. This creates a situation where output and productivity increase. Conversely, higher interest rates mean consumers don’t have as much disposable income and must cut back on spending.
When higher interest rates are coupled with increased lending standards, banks make fewer loans. This affects not only consumers but also businesses and farmers, thus slowing productivity or reducing the number of employees. The tighter lending standards also mean that consumers will cut back on spending, and this will affect many businesses’ bottom lines.
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