SARB MPC expected to announce 25 basis point reduction in repo rate

By John Loos, Household and Property Sector Strategist, FNB.

Our Firstrand expectation is for a 25 basis point interest rate cut in the SARB’s Repo Rate, when its Monetary Policy Committee (MPC) meeting concludes on Wednesday. Should this happen, it would lower the Repo Rate to 6.5%, and the Prime Lending Rate of banks to 10%.

From an “inflationary pressures” point of view, such an expected decision would appear completely justified, with the most recent CPI (Consumer Price Index) inflation rate for February at 4%, now in the lower half of the Bank’s 3-6% target range. In addition, in the early stages of the year the Rand has performed relatively strongly, thus curbing imported price inflationary pressures

The expected rate cut is expected to be a “once-off” in 2018, implying a minor direct impact in terms of lowering monthly repayments on Household Debt. However, it can have a more significant impact due to its potential to drive further improvement in consumer and mortgage lender sentiment. We expect such an impact, because from early-2018, following the change in ruling party leadership followed by a change in the country’s president, it would appear that general sentiment amongst investors, business people and consumers alike may have improved somewhat. It is thus likely that in this environment they are “susceptible” to good news boosting morale further.

We therefore expect that an expected lone rate cut will, along with already-improved economic growth recently, assist in driving mildly stronger residential demand, lifting average house price growth in 2018 to nearer to 5%, following a weak 3.8% average price growth in 2017.

A rate cut at this stage is unlikely to cause any unwanted “over-exuberance” in the housing market though. We say this because, with average mortgage lending rates likely to remain just above 10% even in the event of a rate cut, far in excess of average house price growth still well-below 5%, it remains extremely difficult for speculators, or over-exuberant investors focused more on capital growth on property than on its rental income stream, to make quick profits using cheap credit.

So from a housing market near term health point of view, a rate cut would not be of much concern.

WILL RATE CUTTING END THE DECLINE IN HOUSHOLD INDEBTEDNESS AND THE UPWARD MOVE IN SAVINGS?

What we will watch with interest in the medium term though, is the trend in the all-important Household Sector Debt-to-Disposable Income Ratio. This ratio has been on a very healthy gradual downward trend since its all-time high of 87.8 reached in the 1st quarter of 2008, and it has declined to 71.2 by the final quarter of 2017. This declining trend has been a crucial factor in lowering the Household Sector’s, and thus the Housing Market’s, vulnerability to economic and interest rate “shocks”.

But will improving sentiment, fueled in part by a rate cut, end this downward trend? Last year’s lone rate cut didn’t achieve this, but it becomes a possibility in the current environment of improved sentiment

In addition, the ongoing low interest rates may not be enough to promote a respectable savings rate, the savings shortage in South Africa in general being a major constraint on the country’s ability to fund its Gross Domestic Investment. This is an ongoing “risk factor” for the Household Sector and thus for the Housing Market.

The Household Sector is a poor contributor to overall domestic savings, but in recent years we have seen some small signs of improvement.

Net Household Savings (Gross Household Savings less Depreciation on Fixed Assets) started to show noticeable improvement from early-2014 (around the time that interest rates began to rise), having recorded a dismal Net Dis-savings rate of -2.4% of Household Disposable Income at the end of 2013. By the 3rd quarter of 2017 it reached Net Savings Rate of +0.4% of Household Disposable Income, the highest Net Savings Rate since a stage of 2005 but still very weak, before ending 2017 at a slightly lower +0.2% rate.

To what extent that savings improvement of recent years was driven by interest rate hikes from early-2014 to early-2016, and to what extent economic weakness and weak consumer confidence, causing greater financial conservatism, drove it is debatable. But we would expect that where rate cutting not only leads to less attractive income on deposits, but also to stronger consumer sentiment, the Household Savings rate may start to deteriorate once more, and this from an already very weak level.

From a “promotion of savings” point of view, which would be a short term consumer demand negative but a longer term economic growth positive, sustained low interest rate levels may not necessarily be such a healthy situation.

HOUSEHOLD SECTOR INTEREST PAYMENTS VS INTEREST INCOME

Finally, on this note, we take a look at how the Household Sector’s interest payments on debt have changed over the long run, versus the trend in the interest received on deposits. In 1998, when average Prime Rate for the year was a very high 20.5%, the Household Sector’s Interest Income reached a multi-decade high of 7% of Gross Income, a level never seen since. By comparison, in that same year its Interest Paid on Debt reached 10% of Gross Income. Net Interest Paid (Interest Paid less Interest Received) by the Household Sector in 1998 was thus 3.0% of Gross Household Income.

Fast forward nearly 2 decades to 2017. We have a far lower average Prime Rate of 10.3%, implying far lower lending as well as deposit rates. But is the Household Sector as a whole better off for this than in 1998? Its Interest Paid on Debt in 2017 was 6.7% of Gross Income, significantly lower than in 1998. However, Interest Received on Debt was a very low 2.6%. This translates into Net Interest Paid by the Household Sector of 4.1% of Gross Income, higher than the 3% of 1998.

Admittedly, lower interest rates can boost other investment income streams periodically, and households also receive dividend and other investment incomes besides interest income.

But when assessing the direct impact of interest rates, on a net basis (interest income subtracted from interest paid) South Africa’s Household Sector pays more interest these days than it did in 1998.

CONCLUSION

In short, an expected rate cut this week could mildly boost consumer and housing demand, and this would be seen as a short-term positive from that point of view.

However, the bigger Household Sector picture is one of a still-weak savings rate, and still relatively high indebtedness. This can be growth-constraining in the longer run as well as contributing to Household Sector financial vulnerability. In the current environment of improved sentiment, and the memory of the 2008/9 severe Household Sector financial pain fading, the question is whether interest rate cutting off an already low interest rate level could boost credit demand sufficiently as to bring an end to recent trends of declining Household Indebtedness and rising savings rate?

 



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