At the end of January 2016, the South African Reserve Bank’s (SARB) Monetary Policy Committee (MPC) will have its regular meeting to deliberate on interest rates. According to John Loos, Household and Property Sector Strategist at FNB Home Loans, the bank expects that the Committee will raise its policy Repo Rate by 25 basis points to 6.5% , in turn leading to a Prime Rate increase to 10%.
“Consumer Price Inflation to date has been benign, at 4.8% year-on-year for November, but drought-driven food price inflation pressures along with a sharply weaker rand lifting imported inflation pressures has raised concern of a near term rise in the overall CPI inflation rate. As of late, recent events including the renewed Rand deprecation have even led to some speculation about the possibility of a more significant 50 basis point interest rate hike, and a more rapid rise in interest rates thereafter,” he says.
Loos points out that the interest rate hiking cycle, or even speculation around possible hiking, normally brings about a heightened level of queries from individuals regarding whether they should fix their interest rates on their home loan(s) or not. “However, the general line of questioning normally centres around what we expect interest rates to do, with individuals trying to base their ‘fix vs float’ decision on whether they think they can ‘beat the market’ or not. This approach, I believe, misses the very reason why the fixed interest rate offering exists. It exists precisely because economists, try as they may, along with anyone else from accountants with their budgeting, to weather forecasters, don’t always get future predictions right.”
Fixed interest rates are a tool offered precisely because of future uncertainty, he adds. At a number of the MPC meetings of the SARB in recent years, the Governor has warned of key “upside risks” to inflation forecasts that we should not ignore, emanating from high wage demands in our economy, while the Rand remains volatile, and sharp unpredictable periodic weakening in the currency can increase imported price inflation. As for the all-important food price component of the CPI, this is subject to local and global weather conditions amongst other factors, which can greatly influence supply and thus the somewhat volatile food price component of the CPI.
Given the SARB’s 3-6% CPI inflation targeting mandate, it could be forced to act more extremely than expected at some stage (as happened in the 2006-2008 interest rate hiking cycle), should upward inflationary pressures become too severe.
“Typically, in periods of low and ‘declining-to-sideways’ interest rates, it is natural for many people to lose interest in the option of fixing interest rates, but the idea typically becomes very popular when interest rates are rising. There is no right or wrong when it comes to fixing rates, but it is perhaps important to consider some important factors when deciding whether or not to fix rates, as well as to point out that the usual times when people normally rush to fix rates (i.e. when interest rates are beginning to rise) are not always when one gets the ‘best deals’,” Loots says.
Fixed interest rates exist precisely because of the fact that future moves in interest rates are uncertain. Fixed rates should be viewed as a service provided by banks which enables the client to, for a certain period, shift the cash-flow risk involved with fluctuating interest rates onto the bank. The bank assumes and manages the interest rate risk, and the client obtains certainty over the interest rate payment portion of their cash flows. In return for this benefit, the customer can expect to pay some price.
Should floating rates over the period in question average a rate lower than the level of the fixed interest rate for the period, then the client would have been better off leaving his/her interest rate to float. “Conversely, if the SARB were to ‘shock us’ with significant interest rate hiking, and the average floating rate over the period is significantly higher than the client’s average fixed rate, then the client will thank his lucky stars should he have fixed his interest rate at the beginning of the period,” Loots explains.
“While some people may want to use fixed rates to try to ‘beat the market’, my view is that the decision to fix or float should rest on how much certainty one would like over one’s cash flow. For the person that is more keen to avoid risk, even should floating rates average a lower rate over a specific period than the average fixed rate that he/she fixed at, the value for this person is that he/she has cash flow certainty under a fixed rate arrangement for a defined period, be it 1 or 2 years or even perhaps 5 years. Conversely for the more risk-taking individuals, some of whom may feel there is a good chance of very little interest rate hiking due to an underperforming local economy for some years to come, they may feel that they are losing out on an opportunity by fixing rates.”
He adds that it is a personal decision, but when considering whether to fix or not, think about the following:
- What is your appetite for risk? Does the risk of interest rate hiking cause you major stress? If so, perhaps you lean naturally towards fixing.
- How “close to the edge” are you financially? If your overall financial situation gives you very little leeway to absorb any nasty shocks, you may also lean towards fixing rates.