Last week, the Reserve bank (SARB) Monetary Policy Committee (MPC) hiked its policy Repo Rate by a further 50 basis points to 6.75%, a move that will see commercial banks raise their Prime rates to 10.25%. This brings the cumulative rate hiking in the current cycle to 1.75 percentage points (from a Prime Rate of 8.5% to 10.25%) since the start of rate hiking in January 2014.
According to John Loos, Household and Property Sector Strategist at FNB, this means that, on a 20 year home loan of R1 million, the monthly instalment has risen by R1,138 per month since January 2014, while the most recent 50 basis point rate hike alone adds another R331 to the monthly payment.
To date, the Consumer Price Index (CPI) inflation rate has not been troublesome, with the December rate measuring 5.2% year-on-year. But it has been rising, and is expected to rise further to above the SARB’s upper target limit of 6%, driven largely by drought related food price inflation and a sharply weakened Rand. The Reserve Bank is mindful of a bleak economic growth outlook, forecasting GDP (Gross Domestic Product) growth of only 0.9% in 2016, but projects CPI inflation of 6.8% in 2016 and 7% in 2017, i.e. a rate outside the 3-6% target range for the next 2 years.
The SARB still believes that even with the announced interest rate hike monetary policy remains accommodative. Indeed, even after the series of rate hikes since early-2014, South African interest rates remain low relative to the country’s general inflation rate. “From a recent inflation data point of view, there hasn’t been major apparent pressure for a ‘rapid fire’ approach to interest rate hiking. But inflationary pressures definitely have been on the rise of late,” says Loos.
“The 50 basis point rate hike can thus be seen perhaps as more forward looking than backward looking at the historic inflation data. Admittedly, if one looks at some of the most troublesome components of the CPI, they include education, electricity, water and municipal rates, along with food. Interest rates have little real influence over the price setting process in these areas of the economy, so these inflation drivers are largely beyond the SARB’s control. However, the SARB looks to curb the second round impacts from these factors, which can cause general inflation expectations to rise, thereby anchoring broader economy-wide price inflation at a higher rate in future. So we believe that rate hiking is justified even though the Reserve Bank doesn’t have control over all sources of inflation.”
Prime Rate is also above the average rate of house price inflation (recently around 7%), implying a positive real rate should one adjust Prime Rate to a real rate using the FNB House Price inflation rate, according to Loos. “This implies little room for speculation in the housing market by speculators wishing to use cheap credit to make a quick capital gain. Rapid capital growth just isn’t there at the moment.”
He explains that this has led to a trend of slowing residential demand growth, and the further interest rate hiking is expected to sustain this. He therefore anticipates house price inflation to decline from recent levels of around 7% into lower single digit territory, below CPI inflation rates, through the course of this year.
“From a Household Sector Credit growth point of view, the ongoing increase in interest rates should contain it to within lower single digit growth rates, below nominal household disposable income growth, and as such we expect further decline in the all-important Household Debt-to-Disposable Income Ratio. We do believe, however, that gradual hiking by the SARB can assist in correcting certain Macroeconomic imbalances, and is thus desirable.”
According to Loos, “normalising” interest rates is key to healthy functioning of not only the South African, but many other countries’, residential property markets. Property “bubbles” across the world have been driven largely by cheap credit. Withdrawing this massive stimulus in an orderly way should serve to keep “irrational” behaviour in the housing market contained.
“Our expectation is that the SARB will continue to nudge rates slowly higher, possibly reaching a 11% Prime rate towards end-2016/early-2017. The idea will continue to be to ‘normalise rates from abnormal lows, but at a pace that will do minimal harm to an ailing economy,” he concludes.