Interest rate cuts may not prompt swift recovery

The Reserve Bank's decision to cut interest rates by one percentage point, reducing the Bank's prime lending rate from 12% to 11%, brings the total interest rate reduction since the first rate cut in December to 4.5 percentage points.

Though the latest cut is good news for consumers who are in debt, as well as for the property market, the household sector is still recovering from the effect of rising inflation last year. The positive side of this is households will see debt repayments declining further on the back of lower interest rates.

Luthando Vutula, managing executive of Absa home loans, says the further lowering of interest rates implies that mortgage repayments have dropped 23.8% since December, with the monthly repayment on a R500,000 mortgage over a 20-year term down by R344 after the latest rate cut. This translates into a cumulative monthly saving of R1608 on a R500,000 mortgage since December .

But, despite the declining trend in interest rates, the economy remains under a lot of pressure, with implications for employment and household income. The latest cuts are aimed at stimulating the larger economy rather than easing the predicament of households that are experiencing the credit crunch.

While the drop in rates is good news for households, First National Bank property analyst John Loos warns that the level of real interest rates — interest rate less inflation — is always a matter of concern.

“From a consumption point of view, where the interest rate is lower than consumer price inflation, real interest rates can drive a ‘buy now, pay later' culture. A similar culture can develop in the property market when interest rates are below capital growth or perhaps below anticipated capital growth, an alternative measure of real interest rates,” Loos says.

He says real prime using a consumer price adjustment is indeed coming down due to interest rate cuts taking place faster than consumer price inflation declines.

However, Loos says real prime, using house price inflation with which to adjust, is not yet declining. “At present, residential property capital depreciation is the order of the day, and prime rate is around 21 percentage points higher than the house price deflation rate. For many, therefore, the prospect of borrowing in order to invest in property is far less enticing than at a stage of 2004 when prime was 25 percentage points below house price inflation.”

Loos says this is not to say that residential property demand will not show some recovery after the interest rate cuts.

Source: Business Day

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