WHY IS PETROL GOING UP? WHY ARE INTEREST RATES GOING UP? AND HOW ARE THE 2 LINKED?

Date Added: 4/12/2007
Author/Source: Sebastian Mueller & Jessica Linde of BrayCorp Financial Services



"I can preach as much as I want, if people don't feel the hit in their pockets they won't listen”, the Governor of South African Reserve Bank Tito Mboweni recently said in reference to another hike in interest rates.

To understand and appreciate this statement, it is crucial to learn more about the factors affecting the interest rate as this directly affects your disposable income. This requires an explanation of the diverse factors influencing the interest rate. The following shall provide an insight into this topic using, as an example, the price of oil, which is not the only but the most important economic parameter.

We focus on the United States of America who controls the global economy.
If the US Federal Reserve Bank lowers the interest rate (as they have done recently as a result of the US Property Market Crash) this allows growth in the US economy as money is less expensive and as such people are able to spend more. This results in an increase in demand. To accommodate this demand companies enlarge their production.
A growing US economy in turn results in growth in the global economy as the US is a crucial consumer on international markets.
Increased production results in an increased demand for oil, increasing the price of oil. The higher price of oil makes production more expensive, forcing companies to increase their prices, resulting in inflation.

So in summary:

•Lower interest rates in US means more spending
•More spending means more demand
•More demand means higher production (in the US and global market)
•Higher production means an increase in the demand for oil
•Because the demand for oil is higher, the oil price also increases
(This is the law of supply and demand. The more in demand something is, the more it costs. For example, if there are 5 apples but 10 people who want them, those people are prepared to pay more to ensure they get an apple).
•Higher price for oil means the increased production is more expensive
•This means companies would raise their prices (to make up for the increased cost of production)
•This results inflation!

So the overall effect is: A decrease in US interest rates = inflation

What effect do those coherences have on South African economy?

This resultant increase in inflation exerts pressure on the Reserve Bank to raise the interest rates, making money more expensive, resulting in less spending which in turn slows down inflation.

So while the increase in the price of oil affects the cost of our petrol so too is our interest rate affected.