Rising Interest Rates: The Implications
Interest rates are increasingly getting under scrutiny by people; be it forex or stock investors. For those who are contemplating borrowing money from banks, interest rates are influential in their decisions.
When it comes to inflation and controlling inflation, interest rates come into play as central banks use them to control inflation.
When it comes to increasing economic growth, interest rates too are a key consideration. In all of the above parties, there is an effect that rising interest rates have exclusively to each.
Let’s consider the important effects of rising interest rates.
When the central banks increase the interest rate, the commercial banks, in turn, increase their interest rate on loans. They pass on the burden to the borrowers and thus for you to acquire a loan, you would repay it at a much higher interest rate.
This applies to other financial institutions such as mortgage firms. Since a mortgage is a form of a loan, the interest rate you will pay on a mortgage is also set to rise.
Increases the Yield of Deposits
When the interest rate increases, this has the effect of increasing the amount of interest that is payable to you from your initial deposit in banks. By virtue, deposits are a kind of loan that you give to the bank as a saver.
Thus the cost that the bank will have to meet forth use of your money is set to increase. Hence it is a positive implication for all those who have deposits in various banks.
Strengthening of Currency
An increasing interest rate often results in making certain currencies stronger. This is because when the interest rate increases, the purchasing power of the currency also increases.
This gives an incentive to forex investors and forex traders who leverage on the increasing value of currencies. In the case of the US dollar, there are many saving opportunities for US citizens when the dollar strengthens, especially for travelers.
Central banks through monetary policies increase or decrease interest rates in order to achieve a certain outcome in the economy. When the prices of commodities are so high or when the purchasing power of a currency is low, it means that the level of inflation is high.
A high level of inflation means that there is a lot of money in circulation in the economy. It also means that the prices of commodities are exorbitantly high such that you would have a lot of money but you cannot purchase many things with it.
In this case, the central bank seeks to level down the level of inflation so that there is not so much money in circulation. To effect this, they increase the interest rates to commercial banks, who in turn increase the interest rates to those who are borrowing.
When the interest rates are high, banks have more incentive to lend due to the fact that they will part with more money. Also, when there is additional credit in the economy, the impact is normally beneficial in a wholesome way.
Stable Retirement Plans
When you are saving for retirement, you stand to benefit a great deal from high-interest rates. Rising interest rates translate to higher rates of return on your retirement plan. It offers the stability you need for your investment plan, and by extension, the cash needed to fulfill its obligation to pensioners.
Another important effect of rising interest rates is on bond prices. With regard to bonds, rising interest rates have had a negative impact. This is because there exists an inverse relationship between bond prices and interest rates.
Thus, when there is a rise in interest rates, there’s a corresponding fall in the prices of bonds. This gives no incentive to those seeking to invest in bonds since the issuing party will accrue more costs.
In the case of stocks, rising interest rates affect consumer spending. The effect on businesses and consumers will be one that will result in a decline in spending. People will have less disposable income. Consequentially, the earnings of businesses will fall causing the stocks to drop too.
In conclusion, interest rates have had a varied effect on the economy. The general effect of a rising interest rate is the reduction of the amount of money in circulation in the economy.
This is advantageous as far keeping the level of inflation at a low point is concerned. However, rising interest rates also make borrowing to be more expensive; thus affecting the spending habits of businesses and consumers. Rising interest rates are also a disincentive to investment as they lower the prices of stocks and bonds.