Johannesburg - Six times a year, South Africans sit on the edge of their seats waiting to know whether the SA Reserve Bank (Sarb) will push up or lower the repo rate, which consequently impacts on the rates people pay to service debt on their home loans and car repayments. What is the repo rate?
The repo rate, also known as the repurchase rate, is the rate at which the Sarb lends rands to local banks in the private sector.
Fluctuations in the repo rate influence the prime overdraft rate - this is the benchmark rate at which private banks lend out to the public.
When banks lend money to consumers, the interest they charge can be above, at, or below the prime overdraft rate. The rate at which they lend rands to consumers is based on the consumer's spending behaviour and credit history.
Currently, the repo rate is at 12% and the prime overdraft rate is at 15.5%.
So if a bank lends money to a consumer at prime plus one (in other words, at 15.5% plus one percentage point), the rate to that consumer will be 16.5%.
Similarly, if it lends rands to the consumer at prime less three percentage points, the lending rate to that consumer will be 12.5%.
How does this rate get decided?
It all happens when members of the Sarb's monetary policy committee (MPC) get together approximately six times every calendar year and hold a two-day meeting to decide on whether to change the repo rate, which consequently changes the prime overdraft rate.
The committee bases its decision key indicators, some of which include consumer spending inflation (as measured by the consumer price index, CPI, and CPI excluding mortgages) and factory gate price inflation (as measured by the monthly producer price index, or PPI).
The MPC has raised interest rates by 500 basis points since June 2006 (for an explanation for the difference between basis and percentage points, take a look at this article.
Tighten, hold, or ease?
Let's use the current repo rate of 12% as an example. If the MPC decides to raise the repo rate by 50 basis points (or 0.5 percentage points), the repo rate will go up to 12.5% (12% added to 0.5%).
This consequently pushes the prime overdraft rate by the same amount of percentage points, to 16%.
When the MPC decides to raise the repo rate, this is termed as 'tightening the interest-rate cycle'. In other words, it is making it more expensive for people and institutions to borrow money.
If an individual has a bond of R700 000 on a house, and they are paying monthly instalments for the next twenty years with the current interest rate of 15.5% - they will pay a monthly instalment of R9 477.17.
However, when the rate goes up by 50 basis points (resulting in the 12.5% repo rate and the 16% prime overdraft rate), that person's instalment will then be R9 738.79, almost R300 more than what they were paying.
The extra rands that borrowers will have to pay to banks means they have less to spend on other goods and services, making phrases like "consumers' pockets are being squeezed" or "belts are being tightened" very common in tough times.
If the MPC puts rates on hold, then consumers and institutions keep borrowing at the same rate as before the meeting, but if rates ease, they pay less.
So if the MPC reduces rates by 50 basis points, the repo rate of 12% will fall to 11.5%, and the prime overdraft rate will drop to 15%.
This means that the individual?s monthly instalment on the R700 000 house will then only be R9 217.53, and borrowers of rands will have a bit more money to spend on other things.
- Fin24.com