Last April was a shock for many, especially for those who predicted a definite hike in bank interest rates towards the end of 2016, or at a push the beginning of 2017.
However, the Yellen meeting held last April placed serious doubts on a hike coming in the near future and is now looking uncertain for even the rest of this decade.
The meeting was unusual in itself and has cast further concerns toward the financial sector and global markets.
Let’s take a closer look at interest rates in banks for the future, and how an eventual rise will affect us…
Why the Yellen Meeting was unexpected…
The fact that this meeting was even held caused concern to the public, mainly because:
- The US president and vice president are never present in the same meeting due to security issues.
- The actual details of the discussion weren’t disclosed to the public.
As USA’s economy has now been displaying signs of slow growth and stability, it was becoming a reality for policymakers to starting to talk about hiking up interest rates; this has not happened since we had the last great recession of 2008.
This sounds promising so what went wrong?
Although the financial situation was starting to look up in 2015, the world’s GDP started displaying signs of stagnation by 2016, due to the following factors:
- The oil supply crisis which caused the price of a barrel to fall sharply.
- Uncertainty between America and Russia, causing trade sanctions to the markets.
- The instability in the Middle East and Africa.
The current global conditions have called for a delay in rates, and the Yellen meeting confirmed this to the majority of economists.
Although interest rates do seem off the table for now, however, when we do eventually get there – here’s what to expect:
What do high-interest rates mean for Borrowers and loan repayments?
Low-interest rates have meant that in the last few years consumers have had access to artificially low-cost consumer loans, home loans, and auto loans.
They are affordable to the majority of consumers because little to no interest is being collected from the loan. However, a small increase in interest rates will bring up the cost of borrowing.
If the consumer is still paying their mortgages and debt, then a hike will put up repayment costs – this can lead to higher home repossessions, and risk putting us back to where we started in 2008 (or worse).
Whilst this eventuality is still far out of reach, it is always best to check whether you have fixed interest or not.
What high-interest rates mean for Small Businesses?
Small businesses have experienced higher growth in the last few months, whilst optimism has remained steady in staff employment.
There has been higher confidence in spending and investment; in contrast, many small businesses have not been borrowing either.
Experts who studied small business operations stated that many won’t borrow on low-interest rates alone; other factors that apply are opportunities to bring returns and the drive from their cash flow. As stagnation in 2008 dampened new investment opportunities, this resulted in many businesses not borrowing despite the low-interest rates.
But the study also found that over one-third of small businesses are still complaining of weak demand from consumers.
So a hike in rates may not affect businesses directly, but a heavier debt burden on the consumer may wipe out demand altogether; this can decrease profits margins.
What do high-interest rates mean for the Bond Market?
The Bond Market panics at the prospect of higher interest rates, especially as it’s sensitive to the rate’s behavior; even a 1% increase would cost you 5% from your bond fund. Consequently, with interest rates remaining the same since 2009, this has caused portfolios to stay low, and bond maturities in the bond index to get a longer duration (6 years and counting so far).
If you have bond funds that have interest rate risk, you might want to consider changing over to credit risk funds instead, such as high-yield bond funds, or floating rate bond funds.
They can offer a higher yield cushion, and the relationship with interest rates is less risky. However, whilst these funds can minimize interest rate risk, you need to be careful of correlation to stocks, and the consequences of greater volatility.
What high-interest rates mean for the Property Market?
An interest rate hike will mean higher mortgage repayments from homeowners, which will leave many with a shortfall of income, and can lead to property repossessions.
Higher cost mortgages will also mean a collapse in demand for buying property, as for many buyers the costs will be too high, especially for first time buyers who have recently managed to take advantage of the low-interest rates offered from mortgages in the first place.
This may revert back to the same property market climate as experienced from the last recession.
What high-interest rates mean for Savers?
Although we would assume higher interest rates would mean higher returns on savers accounts, unfortunately, this may not be the case as other factors also determine for higher saving rates, this includes:
- Levels of competition between accounts.
- The impact of consumer borrowing.
So it’s never certain if the base rate will cause your savings account interest to rise.
It is advised to not wait around for higher interest rates to be set, and to start shopping around now for better interest deals – for example:
- Riskier investments like the stock market.
Why raise interest rates, if it causes so many problems for the economy?
Changing and setting the interest rate base helps the government to control inflation, and to help stimulate the economy when required.
In the present, money is easily obtained with low costs to borrowing which leads to higher demand for goods, which if rates were kept low it will eventually begin to exceed supply. Therefore driving up the price of goods, and resulting in a slowdown of economic growth.
Once the price of goods increases above a certain point, it will kill off any demand, whilst diminishing employment and cuts to production.
How to keep control of inflation
To keep inflation under control, interest rates must be raised to strengthen the currency. This can encourage foreign investment, creating higher demand and value for the dollar, and will encourage US citizens to purchase and invest in foreign markets (The purchasing power of the dollar would be stronger meaning goods are cheaper to purchase abroad).
Objectively this puts pressure on US companies to compete with foreign prices, helping to keep costs down.
Although times are harder initially in the event of an interest rate rise, in the long run, it helps strengthen the economy and its currency, whilst keeping prices down.
With the right planning and having a little foresight into the future; it is always wise to stay on top of finances, check the interest rates for any borrowing or mortgages, and save any disposable income you may have.