Updated: Nov 21
Author: Sidney Williams
Date of Publication: 28/10/2022
Recently, the FED (federal reserve) and the FOMC (federal open market committee) have been meeting up to increase interest rates. This happened due to the global circumstances which have resulted in massive inflation. Consequently, this creates a lot of fear in the financial markets such as the stock market and the crypto space. In fact, not everyone understands the relevance of interest rates. So, that’s why I want to briefly tackle this with you.
How interest rates affect the economy with the inflation
Interest rates are a measure of how much a lender is willing to pay for a loan. When interest rates are high, this means that there is a lot of competition for loans. Therefore, the prices that lenders are willing to pay for loans are high. So, this increases the cost of borrowing and can lead to a decrease in economic activity.
So, when interest rates are high, it can have a negative impact on the economy, as people have less money to spend and businesses may have to lay off workers. Another effect is that it becomes more expensive for consumers to borrow money, which can lead to reduced spending and economic growth.
Additionally, increases in interest rates generally lead to currency appreciation. This is because higher interest rates attract foreign investors. Hence, there will be higher demand for that currency. This appreciation then makes exports more expensive and reduces economic growth. However, when interest drops the aforementioned effects won’t generally take place and vice versa.
Interest rates and the stock market
How do interest rates affect the stock market? Well, when interest rates rise, borrowing becomes more expensive. This also counts for companies. Therefore, they can conduct less business which lowers the value of their stock. Their growth is seen as impaired and expected to fall, due to for example higher debt expenses because of the interest rate change. This lowers the stock value.
Moreover, the demand for stocks will diminish as well. Higher interest rates mean that elsewhere, consumers can invest their money for a better or more consistent return. They will save money instead of spending it on stocks.
So for now, it will be important to keep an eye on the interest rates changes globally. This helps indicate which way the markets will move. Generally speaking, interest rate changes tend to take 8-10 months to show visible effects in the economy. Let's hope we get out of this recession as soon as we can.