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Mar 28, 2023 5 min read

Reasons and Impact for Interest rates hike in an Economy.


Dream of owning a house or having a dream car gets blurred for the public when EMIs increases due to interest rate hikes but the salary of the public or the revenue sources of people in general does not increases with the same pace.

Rising rates is the first tool for monetary intervention as it is the quickest way to drain excess liquidity in the market. When interest rates go up, real rates also rise, leading to the burden on the borrower increasing in real terms.

Inflation with hikes in interest rates combined with recession makes it important for people to understand the reason for interest rate hikes and impact of same:

A. Reasons for current interest rate hikes:

  • Supply and Demand: An increase in the demand for money or credit will raise interest rates, while a decrease in the demand for credit will decrease them and vice-a- versa.

  • Inflation: The higher the inflation rate, the more interest rates are likely to rise. This occurs because lenders will demand higher interest rates as compensation for the decrease in purchasing power of the money.

  • Government: The government has a say in how interest rates are affected. In order to make economy grow and prosper, government and central banks changes the interest rates.

B. Impact of interest rate hikes:

  • Savings :Savings bank interest rates / FD rates gets increased. In theory, that should boost savings among consumers and businesses because they can generate a higher return on their savings. On the other hand, the effect may be that anyone with a debt burden would instead seek to pay off their financial obligations to offset the higher variable rates tied to credit cards, home loans, or other debt instruments.

  • Business Profits: When interest rates rise, it's usually good news for banking sector profits since they can earn more money on the dollars that they loan out. But for the rest of the global business sector, a rate hike carves into profitability as cost of borrowing increases.

  • Auto Loan Rates: Auto sales demand are sensitive to interest rates and gets highly affected with interest rate changes.

  • Mortgage Rates : A sign of a rate hike can send home borrowers rushing to close on a deal for a fixed loan rate on a new home. If interest rates go down, mortgage rates will also go down. Lower mortgage rates mean it becomes cheaper to buy a home and vice-a- versa.

  • Consumer Spending: A rise in borrowing costs traditionally weighs on consumer spending. Both higher credit card rates and higher savings rates due to better bank rates provide fuel for a downturn in consumer impulse purchasing.

  • The Stock Market: Interest rates changes impacts profits and cost of funds which impacts the money infusion in stock market.

Understanding the above impacts will enlighten public to deal with the various changes and burdens being levied on pockets of public.

Also , it’s a well said fact that “ If a person understands the reasons and impacts of any changes , it is easy to deal and find solution for the same”.

     

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