Interest Rates: What to Expect

When it comes to economics, six months is a very long time. In January, South Africans were warned to brace themselves for a rising interest rate cycle. Accelerating inflation, a weakening rand, severe drought and increasing food prices were driving this cycle.

Now, here we sit in August and circumstances have changed. The rand has bounced back slightly and our country’s inflation rate is expected to decelerate. While economic growth is still sluggish, the oil price has stabilised and there is a lack of demand driven pressure. These two factors have combined to lower inflation projections.

As a result, investors’ decisions about asset allocation may have been influenced.

‘The rand has bounced back slightly and our country’s inflation rate is expected to decelerate’

It is unlikely that the interest rate cycle will change much in the next year, according to Ashburton Investments fund manager, Lesiba Ledwaba.

“Local rates are also impacted by global trends and global monetary policy is increasingly dovish,” Ledwaba says.

“Expectations are that the US Federal Reserve would hike interest rates gradually over the next 12 to 18 months” he says.

Concerns over Brexit

Additionally, the US Federal Reserve Bank is worried about future uncertainty and risks with regard to the Brexit decision. Lots of analysts do not anticipate a US interest rates hike for the next year.

It is also unlikely that other central banks will hike rates any time soon. In the UK, concerns that economic growth could slow have increased the likelihood of interest rate cuts.

Negative interest rates have been introduced by the European, German, Swedish, Danish, and Swiss central banks in order to get banks to lend and invest more. In Japan, the hope is that negative interest rates will spur lending, prompt inflation and revive the sluggish economy.

‘Negative interest rates have driven the carry trade back to emerging markets, strengthening these currencies’

Impact on Emerging Markets

However, low and negative interest rates seem to have only driven the carry trade back to emerging markets, in turn strengthening these currencies.

Consequently, emerging market bonds – particularly SA government bonds – benefitted significantly, as the low bond market has seen inflows of around R 61 billion in 2016.

“A low interest rate environment helps moderate the cost of debt and this is positive for consumers who are financing debt repayments to varying degrees. Anything that consumers save in debt repayments, they are likely to spend with retailers.

“If the US economy proves to be resilient and we start to see inflation sooner than expected, then it is likely that US Fed will increase rates and this could reverse the flows.” Ledwaba says.

‘Due to uncertainty around Brexit, central bankers will keep monetary policy very flexible’

Portfolio inflows to all emerging markets, including South Africa, are notoriously unstable, as they are based on market sentiment and won’t necessarily further strengthen the rand.

However, Japanese and European economies have been slow to respond to quantitative easing, and uncertainty around how Brexit will impact the UK economy is expected to continue. This may mean central bankers will keep monetary policy very flexible.