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The South African Reserve Bank has the constitutional mandate to protect the rand against hyperinflation. Its monetary policy employs interest rates to affect inflation and keep it between the targeted 3-6%. Like a manipulative partner, interest rates wield power to cut down or boost inflation.
The connection between inflation and interest rates reflects supply and demand principles.
What follows here is an oversimplified explanation of a complex interplay.
When inflation rises, consumers have to pay more for the same goods and services and thus have less purchasing power. As people cut back on spending, the economy is at risk.
As a consequence, central banks respond with increased interest rates to strategically combat runaway inflation. Higher interest rates make it more expensive to borrow money (e.g. bank loans), ideally pulling money out of circulation to force down prices.
When done correctly, inflation eventually declines. With economic growth slowing, interest rates are also lowered to stimulate the economy.
This ebb and flow continue perpetually, with inflation rising and falling as interest rates chase it with a lag.
John planned to buy a car. However, due to increased interest rates, he cannot afford a loan and decides to make do with his old skedonk for a while longer. The same thing happens to many of the car dealership’s potential clients. Consequently, they are forced to drop their prices for the business to survive. Many other companies need to act similarly. And voilà! – inflation is curbed.
With this economic slowdown, loans become more affordable, and John finally buys that car he was dreaming about. So does many of his neighbours. The economy is healthy, but inflation is on the rise again, and a monetary policy response is now hot on its heels.
Investment and asset portfolios are intricately influenced by the curves of inflation and interest rates. Protecting investments from economic changes involves long-term goals and a strategic rebalancing of investment options.
Need help managing and safeguarding your investments through the ups and downs of the economy? Our experienced team at Huysamen Westraad is well-equipped to help with your financial planning and management. You are welcome to book a consultation with us.
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