On Thursday, the Monetary Policy Committee (MPC) decided to increase the repo rate by another 75 basis points (bps). The increase will see the repo rate increase to 5.50% per year.

The decision was made on the back of the South African inflation rate surging above the South African Reserve Bank’s target range. Increasing interest rates is a key monetary policy tool used by the SARB to manage inflation.

Interest rates in the United States have been steadily increasing and as a result, the dollar has strengthened significantly against the rand, sitting at around R17 to the dollar at the moment.

The SARB look set to continue to increase interest rates in order to manage inflation, and South Africans should expect further rate increases as the year progresses.

Effect on different asset classes

The most recent 75 bps rate increase will have the following impact on asset classes:

Equities

“An increase in interest rates is generally negative for equity stocks. Higher interest expenses, lower market value of assets as well as a decrease in consumer spending capacity results in negativity for certain sectors in the market,” says Bheki Mkhize, CEO Wealth and Investments Solutions at FNB.

He further explains the impact on equity stocks and how it will differ per sector:

• Retail and consumer–facing shares would be most unhappy at the news of a rate increase. Higher interest rates have a negative impact on consumer spending, since it’s more expensive to borrow money, and this will have a negative impact on the share price of retail and consumer-facing companies.
• Companies with high debt levels will now have to spend more to service that debt, which could have an impact on the cash flow of these companies and potentially impact their share price negatively.
• Banks and insurers will be positively impacted by the interest rate increase. For both industries, interest rates are a key driver for margins and an increase in the rate will result in positive economic sentiment.

Cash

A higher repo rate results in higher income for those holding cash investments, which is particularly useful during bouts of market volatility. The recent increase in rates will see cash instruments becoming more attractive to SA investors and savers.

Bonds

Bond holders will not welcome an increase in the repo rate. Typically, an increase in the interest rate results in local bonds becoming less attractive to investors, due to the higher interest rates offered in cash-related instruments. This results in an increase in bond yields and a decrease in bond prices, impacting bond holders negatively.

Preference shares

Like cash investments, preference shareholders will see the increase in rates as good news. Most preference share investments are linked to the prime lending rate, thus a rate increase results in higher dividends received, increasing the dividend yield as well as the market value of the asset class.

Impact of the rate increase on consumers

Rising interest rates mean rising borrowing costs for SA consumers, which will decrease their spending capacity.

Companies that use debt to conduct their business are going to incur higher operating costs, and these costs are typically passed on to the consumer.

The increase in the fuel price is a large contributor to the rising inflation levels. Not only does it mean higher vehicle running costs for consumers, but it also contributes to an increase in the price of consumer goods due to higher logistics expenses.

As a result of rising inflation and interest rates, SA consumers are ultimately going to pay more for a basket of goods.

Consumers must be wise in the types of debt utilised. During times of increasing interest rates, short-term debt facilities should be avoided if at all possible.

Credit card debt and short-term overdrafts are very expensive forms of debt and are typically linked to the variable interest rate. Consumers must be careful not to increase debt levels during times of increasing interest rates, and should make every effort to live within their means.

Impact of the rate increase on investors

Consumer stocks will be impacted on account of higher interest rates and inflation. SA investors should keep in mind how the reduction in consumer spending capacity will impact the listed retail sector.

There are certain oil companies that will benefit from rising oil prices. Higher oil prices result in higher profits for oil companies.

Mkhize further highlights that “Higher interest rates are also generally negative for the bond market but positive for cash (although higher inflation may still see negative real returns on cash instruments).

“Ultimately there aren’t too many places for investors to hide when inflation is on the rise, however diversification through the incorporation of different asset classes within a portfolio is still the best strategy,” concludes Mkhize.

This post was based on a press release issued on behalf of FNB.