A festive season windfall for some
Were you wondering where you’d get the cash to pay for the toll roads on your year end holiday? Your worries are over. Last week Thursday Reserve Bank governor Gill Marcus announced another 50 basis point reduction in the Repo rate – from 6% to 5.5%. As this cut filters through the South African banking system your home loan and hire purchase instalments should drop by a hundred rand or two. A half percent interest cut means the monthly repayment (over 20 years) on a R1 million bond will fall by roughly R324, to R8 997. The cumulative reduction in monthly bond repayments on a loan this size, going back to December 2008, now stands at R4 542!
The flipside of the November 2010 interest rate windfall is the damage it does to retirement incomes. Thousands of South Africans – directly through savings or indirectly through pensions – rely on fixed deposits, money market products and government and corporate bonds to get by. Each interest rate cut wreaks havoc on the returns earned from such investments… And we intuitively know the decline in incomes due to lower interest rates will impact “harder” than the decline in expenses courtesy the current low inflation environment.
On the interest rate, rand and inflation
FNB Home Loans strategist, John Loos, reckons the latest cut should provide some much needed impetus for the bombed out residential real estate industry. “We’ve had two cuts over the past two months, which should provide some mild stimulus for residential property demand,” he said. But he cautioned against expecting fireworks for residential property. Because despite the massive relief from a combined 650 basis point cut in rates, the latest Reserve Bank Quarterly Bulletin points to stubbornly high levels of household indebtedness. Loos notes: “The debt-to-disposable income ratio for the 2nd quarter of 2010 is 78.2%, and that’s not far below the all-time high of 82%.”
What can we read from the Reserve Bank’s decision? We already known Marcus and her team paid little heed to trade union calls for aggressive monetary policy intervention. They’ve stuck to their “tried and tested” inflation targeting strategy without wavering – which means their latest decision has more to do with the benign inflation outlook than anything else. Consumer price inflation has settled nicely within their 3% to 6% inflation target range. “The most recent consumer price inflation rate was 3.2% year-on-year, close to the lower end of the target,” said Loos. He singled out the strong rand as a major weapon in the war against escalating prices…
Currently hovering around R7 to the dollar, the rand has become the Dr Jekyll and Mr Hyde of the domestic economy. On the plus side it’s keeping prices of imported goods in check – and reducing the price tag for massive capital projects such as Eskom’s Medupi and Kusile power plants. On the minus side exporters and manufacturers are suffering. We’re undoubtedly going to see the impact of the strong currency on companies relying heavily on “offshore” markets.
Could we see a sharp unravelling of CPI next year?
Loos raised concerns over the impact of regulated price increases on inflation through 2011. “The electricity component of the housing CPI still shows high inflation of 18.3%, while the “water and other services” component also shows a high 9.3%,” he said. These price escalations have been “cancelled out” by a weak rental market, and declining rental inflation. Remember – rental inflation and owner-occupied inflation are very important components of the overall inflation basket. The CPI for housing has already jumped slightly from 6.26% in August 2010 to 6.31% in September thanks to a revival in rental inflation. And owner occupied inflation can be expected to follow suit.
What should you do if you’re looking to buy a house today? Loos warned against two risks stemming from rising housing CPI: “Firstly, new homeowners need to make provision for big electricity and water and other utility tariff and hikes.” They should also take cognisance of the impact of rising housing inflation on the overall CPI… Interest rates are at historically low levels, and if historic trends can be trusted the next hiking cycle could b fairly extreme. Make sure you can service your bond repayments at prime plus a few hundred basis points.
Editor’s thoughts: The latest interest rate cut illustrates one of the ironies in the world of financial planning. Those who’ve saved religiously to fund a comfortable retirement watch their disposable incomes wither away with each rate cut – while those spending like there’s no tomorrow benefit as their debt servicing costs decline. Are you struggling to find appropriate “low risk” solutions for retired clients? Add your comment below, or send it to [email protected]
