The monetary policy committee of the SA Reserve Bank decided on
Thursday to cut the repo rate by half a percentage point to 11.5%.
What is the repo rate?
By law, banks must have a certain amount of cash on hand. To meet this
requirement, they regularly borrow money from the government-controlled
Reserve Bank. The interest rate that the Reserve Bank charge is called
the repo rate. If that changes, the banks usually follow suit and
change their rates. (Prime rates are the interest banks charge highly
The repo reached 13.5% in September 2002, before it fell to 7% by April 2005.
The bank started to hike the repo rate again in June 2006.
The Reserve Bank's main mission in life is to keep inflation
between 3% and 6%. (Inflation is the rate at which your money loses
buying power every year.)
Currently, inflation is 12.4% – more than double the maximum level of 6%.
The main way the bank tries to tame inflation is by raising interest
rates. If credit is expensive, people will buy less and the demand for
products will drop. If demand shrinks, prices usually also decrease.
(The more money chasing products, the higher sellers can push prices.)
The Reserve Bank also keeps a watchful eye on the rand. If the rand
weakens against other currencies, it's bad news for inflation. Imports
become more expensive, pushing up prices in SA.
The rand's value is largely determined by foreign buyers. Many buy
rands because they earn fat SA interest rates, compared to the paltry
rates on offer elsewhere. In the US, rates are down to 1%, while in
Japan, yen buyers get less than 0.3%.
By keeping interest rates high, the Reserve Bank supports the rand.
This is important, because South Africa has one of the biggest
current account deficits in the world. The current account is the
difference between what we export and what we import. SA imports much
more than it exports. To buy the imported products, you have to sell
rand and buy another currency, putting a strain on the rand.
So why the change in heart?
Inflation has started to come down (from 13.6% in August) and will probably slump spectacularly next year.
The oil price – which has fallen from more than $147 a barrel
in July to below $40 this week – will contribute to lower prices for
all products that need to be transported. Food prices should also drop
thanks to good crops.
There are also technical reasons. The consumer price index, which
measures the inflation ordinary South Africans experience, is based on
a set selection of goods and services. The composition of this "basket"
has been changed and will come into effect from January 2009.
Economists expect the change to decrease the inflation number.
Also, a rate-cut frenzy has gripped the world amid the worst
financial crisis in 80 years. Twenty of the world's richest countries
have slashed interest rates, some coming close to 0%. As more countries
lower their interest rates, it means we can too – without putting the
rand in much danger.
Probably one of the main reasons behind the Reserve Bank's decision,
however, was the alarming slowdown in the SA economy. The latest data
showed that parts of the economy – including retail – are already
shrinking. This shows consumers aren't spending money, which should
also help inflation.
What does this mean for you?
If the rand stays relatively stable, some economists expect
interest rates to come down another 3.5 percentage points next year.
This means that a monthly repayment on a home loan of R500 000 will be
more than R1 400 cheaper by the end of 2009 than it was earlier this
Your car instalment and others loan repayments should also come down.
And for savers, lower interest rates mean you'll earn less on your
But some experts hope that the rate cut will get the struggling housing
market a boost. And for many debt-ridden South Africans, this will be
the first break they've had in a while.
Do you think interest rates will continue to drop? Leave your comment in the box below...