Inflation, interest rates and you

Use the interest rate cut to reduce or wipe out debt

Although low interest rates make it cheaper to borrow money, experts caution that you should instead use the opportunity to reduce your debt and ensure you earn more than inflation on your savings.

Even though you can’t do anything to stop inflation, you can learn how to manage your finances better to be able to cope with inflation. Picture: 123RF/ ANDRIY POPOV
Even though you can’t do anything to stop inflation, you can learn how to manage your finances better to be able to cope with inflation. Picture: 123RF/ ANDRIY POPOV

Inflation and interest rates are in close relation to each other and tend to move in opposite directions, which means that when interest rates are reduced, more people are able to borrow more money, resulting in more spending and an increase in inflation. The opposite is true for an increase in interest rates.

Last month, the South African Reserve Bank’s monetary policy committee reduced the repo rate, the benchmark interest rate at which it lends money to other banks, by 25 basis points to 6.5%, mainly to encourage spending to help stimulate economic growth. When the Reserve Bank changes the repo rate, your bank will charge you interest rates accordingly. 

Currently, the prime lending rate, the lowest rate at which your bank starts lending you money, is 10%.

The latest drop in the interest rates means that savers earn less interest, but borrowers are charged less interest.  

We must fundamentally stop living beyond our means and drive a savings culture to break the cycle of inter-generational debt.
SA Savings Institute chair Prem Govender

However, although low interest rates make it cheaper to borrow money, experts caution that you should instead use the opportunity to reduce your debt and ensure you earn more than inflation on your savings.

“For every rand earned, nearly three quarters is spent on debt,” says SA Savings Institute chair Prem Govender. 

“We can blame issues such as high unemployment, black tax, a rising tax burden and inflation – but we also must fundamentally stop living beyond our means and drive a savings culture to break the cycle of inter-generational debt,” she says

This interest rate drop is a great opportunity to make a dent in that debt.

Jacques Celliers, CEO of FNB says lower interest rates create an opportunity to build a buffer into your budget for when you consider long-term loans for a house or a new car. “Sensible borrowing is a valuable financial tool to enable important moments in your life such as housing, education and unexpected emergencies. Loans should be used in a way that balances the cost of long-term gains with day-to-day living expenses,” he says.

For savers, if you put your money into an account with an interest rate that doesn’t match inflation, your savings will actually lose value. For example, the R100 you had in June 2018 is now only worth R95.50, at the annual inflation rate of 4.5% (as measured in June 2019), explains Marietjie Bennett, director: price statistics compilation at Statistics SA. Or, put another way, “to have the same value as the R100 in June 2018, you need R104.50 in June 2019.” 

So, what is inflation and how is it measured?

Every month, Statistics SA releases the annual consumer inflation figures, which answers the question: to what extent has the cost of living gone up (or down)? 

Their measurement, known as the consumer price index (CPI), is based on a “basket” of 412 goods and services that the average household uses. It is determined by the total spend (countrywide) on an item, as well as by the number of households that buy a particular item. It doesn’t include overly expensive items, like jet skis or quad bikes, that few households buy – or cheap items, like matches, that have little effect on our pockets.

The items carry different weightings, according to how much of the average household budget they take up, Statistics SA says. As this changes over time, the basket is reassessed every four years, and was last adjusted in January 2017. Instant noodles, frozen pizzas and pies, ready-mixed flour products, levies for sectional title schemes, video games, diesel and driving lessons were added to the basket. And in a sign of the times, postage stamps and pre-recorded DVDs, among other items, were dropped. 

The food portion of the basket consists of 124 products and, of these, 34 are considered minimum food needs. Food and non-alcoholic beverages make up just over 17% of the current basket.

Statistics SA explains that they monitor price by employing price collectors who visit sampled outlets and markets every month to record actual prices on the shop floor, to assess the overall change in price. These changes show the increase (or decrease) in the cost of living – which is the rate of inflation (in layman’s terms). However, Statistics SA notes that in our own households, we might experience inflation at a different rate, depending on the types of goods and services we use.  

To define it more formally, the annual inflation rate is the change in the consumer price index in the current month compared to the same month a year ago. This change is expressed as a percentage. Since April 2017, inflation has averaged 4.7%.

Ensure that you spend only what you need and that you exercise the discipline to stick to your budget. That way, you can put any leftover money straight into your savings, where it can sit until you really need it
Old Mutual Finance

So how do you prepare for the effects of inflation?

Save

Even though you can’t do anything to stop inflation, you can learn how to manage your finances better to be able to cope with inflation. The first thing to do is ensure that you save properly and set aside a little nest egg that you can make use of when prices increase, says Old Mutual Finance. “Having an emergency fund will help ensure that you aren’t completely stretched when the costs of living rise.”

Reduce debt

Try to pay off any outstanding debt, starting by paying any extra you can towards the debt with the highest interest rate - while still making sure you pay the minimum you owe on the others. With the reduced interest rate, your debt has become cheaper, providing a great opportunity to pay it off quicker. If you have multiple debts, use the snowball effect where if the one debt is settled, you use that money to settle the next debt faster.

Budget

If you don’t have a budget yet, you need to set one up right now. If you already have one, it is time to review it, advises Old Mutual Finance. Where can you cut your spending each month and save a little extra? “Ensure that you spend only what you need and that you exercise the discipline to stick to your budget. That way, you can put any leftover money straight into your savings, where it can sit until you really need it,” says Old Mutual.

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