Gino Rossi: Share World
As the Asian economic turmoil abates, South African financial markets are again speculating about the possibility of an interest-rate cut.
For the past three weeks the rumour mill has been spinning at a fast pace, particularly on Fridays when the South African Reserve Bank usually makes announcements about cuts in the interest rate.
Economists have been predicting a cut of at least two percentage points in the next 12 months because annual inflation looks set to fall to 5% and economic growth rate is unlikely to be enough to stimulate job creation.
A fall in interest rates will stimulate financial markets as well as the economy generally, although the speed and magnitude of the effects will vary between the different sectors.
The most immediate and obvious results of an interest-rate cut are felt by anyone with a bank account since the interest charged on loans and paid on deposits drops. Interest rates also determine investment strategies by individuals and companies, which in turn affect consumer buying power and, ultimately, employment opportunities.
Interest-rate cuts impact on the stock market in various ways. Lower rates mean people tend to have more money in their pocket, so retail stocks such as food, furniture and clothing are generally among the first to feel the benefits. This extra spending has a ripple effect on other sectors, such as property.
Some analysts believe the stimulus of lower interest rates will not really impact until a year later. Consumers will be likely to spend any extra income extricating themselves from their debt burdens before going on a spending spree.
Declining interest rates also benefit companies with large capital expenditure and big debts. As the cost of corporate borrowing declines, companies tend to produce better results, which in turn push up their share price. For this reason, one analyst said he expected the Johannesburg Stock Exchange’s industrial board to show the most uniform benefits, because such companies tend to be capital-intensive and rely more on debts.
The effects of a rate cut can vary within sectors as well as between them. Financial stocks do well in high and low interest-rate regimes. Last week saw the financial index reach a record high. But within the sector, financial institutions will be affected by how their portfolio of investments, debtors and creditors has been arranged. A major factor is how quickly an institution can reprice its borrowings to take advantage of lower interest rates.
Interest-rate cuts generally stimulate people to move out of cash assets into investments which are likely to provide more income growth. South Africa’s tax system also adds to the allure of equities since there is no capital gains tax on such investments. Cash holdings attract interest, which in turn attracts tax.
However, one analyst pointed out there is a big difference in South Africa between dividend yields and deposit call rates. This means a cut in interest rates is less likely to stimulate such switching than in countries where the differential is smaller.
The effects of an interest-rate cut are crucially affected by its timing. Last year’s cut was totally overshadowed by developments in Asia which caused virtually all the initial gains on the stock market to be swept aside, and brokers have had a hard time of coaxing wary investors back since then.
The exception was banking and financial shares which managed to outperform most of market on continued expectations of a cut. Those shares generally gain just before and just after a rate cut.