What high interest rates mean for your money

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Interest rates have risen worldwide, notes Kondi Nkosi – head of country for Schroders in South Africa. In the US, the Federal Reserve (Fed) has already raised interest rates twice this year: by a quarter of a percentage point in March and by half a percentage point in May.

They are now at 0.75%-1% in the US and 1% in the UK after the Bank of England, the UK’s central bank, raised rates four times since December 2021.

In Canada, too, the interest rate is at 1%, where the central bank has raised interest rates twice this year, while in Australia the interest rate has risen to 0.35%. They have also grown up in many emerging markets including India, Mexico and South Africa.

Locally, South African yields are at their highest level in five years – on July 21, the South African Reserve Bank (SARB) announced that interest rates would rise by 75 basis points (bps), pushing the repo rate to 5.5% came and the prime lending rate to 9%.

The rates are expected to continue to rise. Our economists at Schroders predict that rates in the US will reach 3% by the end of the year and that they will reach 2.25% in the UK sometime in the first quarter of 2023.

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What are interest rates?

The interest rates represent the cost of borrowing.

When a central bank, such as the South African Reserve Bank, Bank of England, US Federal Reserve or the European Central Bank announces a new interest rate, it determines the cost to local banks when they borrow. This in turn determines the rate at which banks lend to each other, and it also affects the rate at which they lend to the consumer (that is, you).

So if the bank interest rate goes up, you would expect your mortgage interest rate to go up as well and vice versa. (Of course, other factors come into play in determining mortgage rates, including the stability of your income.)

Why are interest rates rising?

Central banks are currently raising interest rates to keep inflation (rising prices and declining purchasing power) in check. Most central banks have an inflation target or an inflation target band.

For example, the inflation target of the Bank of England and the European Central Bank is 2%, while the Fed is aiming for an average inflation rate of 2% over the long term. Current annual inflation in both economies is near a 40-year high at 9% in the UK and 8.5% in the US and 7.5% in the Eurozone (as of April 2022).

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In South Africa, the Reserve Bank’s target margin is 3 to 6%. Current annual inflation is over 7% (as of June 2022).

Central banks try to influence spending patterns when they change interest rates. Interest rates affect the general level of activity in the economy.

If the interest rate is higher, we are more likely to save because we earn more interest on our savings. Borrowing is also more expensive. This reduces spending in the economy, which tends to dampen inflation.

Importantly, higher interest rates have no immediate impact — it takes time for their effects to permeate the economy.

Savings, loans, credit cards and store credit: what does higher interest mean?

In general, a rise in interest rates is good for savers (you earn more interest on your savings) and bad for borrowers (you have to pay more for your loan).

As interest rates rise, you should expect to pay more for mortgages, loans, credit cards and store credit. Lenders normally quickly pass on rate increases to borrowing customers.

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Some loan agreements — including certain mortgages and credit card agreements — have rates that are fixed for a period of time. But they usually go back to a floating rate at the end of that term, so check the details of any credit agreements.

While you will see a lot of headlines about higher inflation and rising rates, the fact is that interest rates in most countries remain very low compared to their long-term averages.

What does this mean for my investments?

The good news is that if you have a well-diversified investment portfolio, some of the assets you invest in can benefit from higher interest rates, such as cash. Conversely, you may see a decline in assets such as bonds.

While we are experiencing extremes in the market, the basic pillars of good investing still exist, such as staying calm and avoiding hasty decisions, staying invested, and talking to a professional financial advisor about potential changes to your portfolio.

  • By Kondi Nkosi – Head of Country for Schroders in South Africa

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