Repo rate raised 50bps to 11.5%

The South African Reserve Bank increased the Repurchase Rate today by 50 basis points. As usual, all the talking heads are out explaining why this was exactly the right thing, exactly the wrong thing, exactly the right thing for the wrong reason and several other combinations.

Historical levels of Repo

updated graphs – Short memory or what

Whatever your view, the following graph shows the repo rate inching towards the 12.5% of June 2002 and on to the 13.5% of September 2002. (Click image for a larger version)

South Africa repo rate since 1999

The steady, incremental increases that have typified Tito Mboweni’s increases since the bottom of 7.0% almost exactly three years ago stands in contrast to the steep mountain created between September 2001 and December 2003. In that period, rates increased by 4% within 12 months, stuck at the approximate level for 9 months before crashing down again by 4% in just 6 months.

Location, location, location. And interest rates

That incredible decrease in interest rates, and thus increase in the loans available to home owners had a critical role to play in the local property market boom that is now faltering in a serious way.

Even John Loss, FNB Home Loans’ property strategist, generally extremely bullish on property is worried:

“I believe that today’s development begins to raise the possibility of a small period of national house price deflation, which under a sideways scenario I believe would have been narrowly avoided”

Another viewpoint is that of RE/MAX’s Jeanne van Jaarsveld, who might have estate agent’s commissions in mind rather than property investors’ returns:

“…the latest rate hike would “further trim the already shrinking volume of residential property sales”.

However he said the “impact would again be cushioned, as have the earlier increases, if sellers lower their expectations on asking prices to effectively absorb the cost.”

A 5% decline in property prices only hurts by 5% if you earn the same percentage commission on the same number of sold houses. If you have geared exposure to the underlying asset, a 5% decline can easily magnify into a decline anywhere from 5% if you own the house outright, to 50% if you have recently purchased the house with a 10% deposit.

The total increase in the repo rate over this cycle so far is 450bps. For a home loan close to inception, this translates fairly closely to a 33% increase in repayment. For more mature loans, the impact will be less, perhaps in the region of 20% on average.

Impact on the economy

The impact on the property market is one of the reasons put forward against higher interest rates. Unlike Alan Greenspan’s apparent views, our Reserve Bank’s mandate has nothing to do with asset prices. Inflation control, currency stability yes. Property prices (or bond prices, or equity prices for that matter) should be of no concern. However, there are concerns around the broader economy. Manufacturing output, consumer confidence and business confidence are down.  Vehicle sales are down. Defaults and bad debts are way up. The full impact of the power shortages have not yet been felt. Higher interest rates will make it more difficult for most.

We want more, Tito… More!?!

However, there are several who believe the rate hikes should have come sooner and harder. Tito Mboweni states in his most recent speech that he (or the Monetary Policy Committee) should have raised rates sooner. Perhaps the slowly slowly approach has not been aggressive enough after all, allowing inflation to increase well outside the inflation targets. We will now have to deal with a prolonged period of high inflation and high interest rates.

And now?

Fiscal spending is still high, some companies have considered that perhaps the power crisis will have a smaller impact on their businesses than previously feared, Zimbabwe may have a chance of new government and South Africa have soundly beaten India in a Cricket Test Match in India. There is good news to be had, but finding it is becoming more difficult.

Given the large swings in the repo rate that we have experienced over the last few years, and given the totally unexpected shifts in both short-term and  long-term interest rates in countries such as the UK, the US and Japan over the last 25 years, who would still try to make long horizon forecasts around the level of interest rates, inflation and economic growth? Weather forecasts are relatively accurate, and weather forecasters have a realistic understanding of their own abilities.  Analysis of the accuracy of economist and analyst forecasts shows them to be poor, hugely overconfident estimators.

Sounds like an argument to manage your organisation’s risk exposure to uncertain, un-knowable, uncontrollable, exogenous effects.

Published by David Kirk

David Kirk runs Milliman’s actuarial consulting practice in Africa. He is an actuary and is the creator of New Business Margin on Revenue. He specialises in risk and capital management, regulatory change and insurance strategy . He also has extensive experience in embedded value reporting, insurance-related IFRS and share option valuation. He has been involved in significant insurance projects across Sub Saharan Africa and in the Middle East.