interest rate
Markets expect this to be a pivotal week, with central banks led by the Federal Reserve meeting on July 25-26 to decide the stance on interest rates and the fate of monetary tightening to curb inflation.
Decisions related to interest rates are usually widely concerned and expected by various departments, investors at different levels, individuals and institutions. Public interest in, and follow-up to, these decisions and the details of monetary policy have increased in recent years, given the broad economic pressures facing the international economy and the impact of these pressures on prices and living conditions, and as awareness of the nature of monetary policy and its implications has grown.
In this case, “interest rate” is one of the most important indicators, and everyone eagerly awaits relevant updates from regular meetings of central banks around the world, especially because it sends a clear message about economic trends and prospects.
So what is “interest”? How do interest rates affect the economy and people’s lives? When will monetary and financial policy authorities raise interest rates? When to reduce or install it? What is the relationship between economic conditions such as inflation, recession, deflation and interest rates?
What does interest mean, and how does it relate to inflation?
Banking expert Sahar Al-Damaty told Sky Arabia News:
- The main objective of central banks is “price stability” and to achieve this and curb inflation or face recession, they use various existing tools, the most important of which is “interest rate”.
- Interest is the return on money invested in the bank, and the interest rate is adjusted (by raising or lowering) according to the rate of inflation.
- When inflation rises, interest is increased; to contain it, while interest is decreased if inflation reaches the target rate (the natural limit),
- Controlling inflation in this way is what central banks have been doing since last year, when they responded to high inflation with monetary tightening and rate hikes.
Regarding the impact of lower interest rates, she explained that low interest rates stimulate borrowing, which in turn leads to more spending, which then increases activity, as well as business sales and higher profits.
Conversely, in the case of high interest rates, this leads to higher borrowing costs at the individual and business level, lower spending and demand for goods in general, which means lower corporate profits and delays in expansion and development plans due to high borrowing costs (potentially leading to a recession).
interest rate impact
Regarding the impact of interest rate decisions (whether they are lowered or raised) on individuals, financial market expert and economic analyst Dr. Hossam Al-Ghayesh explained in an exclusive statement to Sky Arab Economic News that a decision to raise rates could be bad for borrowers and those seeking financing for projects, but on the other hand could be good for savers.
He pointed out that the owners of bank deposits benefit from an increase in the interest rate, the price of the deposit increases, and the customer’s income increases accordingly, explaining that the bank’s interest, whether it is a deposit or an investment certificate, is called “return without investment risk”, which is the minimum return obtained and is completely risk-free. He also pointed out that this is important whether for savers, depositors or borrowers.
He added that each of the aforementioned categories differs by the impact of interest, as follows:
- If interest rates are high, it will have a significant impact on reluctance to invest and seek to benefit from high bank interest rates; if they are low, it will encourage savers to invest more.
- So for individuals, interest rate decisions have a big impact, especially those with large financial deposits, as it may induce them to put their available financial liquidity into the bank, through various banking instruments or products, be it investment certificates or deposits etc.
- As for the impact of interest on corporate and individual investors, capital market experts explained that they are greatly affected because they all pursue the highest degree of profitability and profit maximization. When the prices of banks are high, investors will try to channel financial liquidity to these banks as much as possible in order to profit from the high interest rates.
- If an investor wants to borrow money when interest rates are high, he will avoid taking this step during the upswing because it will expose him to risk.
- Investment and the Free Sector To encourage borrowing from banks, interest rates must be low, or at least must be balanced between market returns on investment and bank interest.
The economist added: “Ordinary citizens are also affected by the decision to change interest rates, because raising interest rates is a result of the central bank trying to target inflation, so the inflation that is already there has an effect on individuals, increasing their spending and consumption, so there is some liquidity in the banks that can compensate them for some of the costs of spending on consumption.”
He pointed out that the central bank has always had a relatively large household sector in banking, deposits and investment, considering that under the circumstances of high inflation, raising interest rates is to compensate consumers for part of the cost of rising prices in the current wave of inflation, and at the same time adopt tools to absorb market liquidity.
The money market expert explained that changes in interest rates have no effect on prices because interest rates respond to rising prices, not the other way around. Rising prices indicate rising inflation, which prompts the central bank to raise interest rates so it can target existing inflation, he explained.
How is the economy affected?
In addition, banking expert Mohammad Abdul-Al said in an interview with Sky News Arab Economy that after the Ukraine war, Europe, the United States and countries around the world have experienced serious price increases, leading to an unprecedented level of inflation in history. This is reflected in the monetary policies of various countries. Central banks have begun to adopt strict or ultra-tightening policies. The simplest tool is to continue to raise interest rates.
He explained:
- The global economy is characterized by interconnectedness, and in general, and especially the interest rate changes of the Federal Reserve Bank of the United States usually have an impact on the economies of countries around the world.
- For example, for oil countries, the interest rate hikes in the United States and Europe will also have an impact on those countries that raise interest rates, especially the currencies of these countries are mostly pegged to the US dollar, and oil futures contracts must be paid in US dollars.
- The rate hike has little impact on the economies of petro-states as they have good cash reserves, so currency values and growth rates have not been affected much, but it indirectly affects investors’ internal borrowing costs, thus affecting non-oil sectors such as real estate and construction.
- And in developing countries, they are most affected by interest rate decisions, when US interest rates rise or stabilize, the price of US bonds and treasury bills will rise, which is more attractive than indirect foreign investment (so hot money flees these countries, which affects them a lot).
- Foreign indirect investments such as bonds and short-term treasury bills in developing countries are affected by high interest rates. Investors withdrew due to high borrowing costs in these countries, and the actual return on investment decreased due to high risks.
The banking expert said rising interest rates led to higher borrowing costs for businesses, investors and merchants, which eventually led to higher commodity prices for final consumers, which led to high inflation continuing and the economy entering so-called stagnation or deflationary inflation, where inflation is accompanied by stagnation.