Most central banks all over the globe usually change their target interest rates in response to a given economic situation. They raise rates when inflation is overly strong and lower the rates when inflation in the economy is sluggish.
Knowing the relationship between interest rates and the financial markets would help investors appreciate how interest rate volatility impact on their investments. This helps them make better investment choices. Investing, after all, isn’t scary as it sounds.
Every time central banks change interest rates, there’s a ripple effect in the economy. If inflation is high and left unchecked, it could lead to a significant loss of consumers’ purchasing power.
Higher interest rates mean higher borrowing costs, prompting lower borrowing. In addition, it becomes more expensive for companies to raise funds.
Last February 15, the BSP’s Monetary Board announced that its benchmark interest rate will stay at 6.5 percent, a 16-year high. It will be rewarding, hopefully, if things turn out right, but numbingly painful if it turns out wrong. Implementing monetary policies, however, should be appropriate to address financial market disruptions. Monetary policy is the favored measure over fiscal policy by conservative policymakers.
The continuing effects of high inflation in our economy remain a major worry. Raising or lowering the key interest policy rate is Bangko Sentral’s way of controlling inflation. As BSP Governor Eli M. Remolana, Jr. put it: “Monetary policy cannot control supply-side price shocks, but it can serve to break the link between those supply-side shocks and expectations, and also the link between those supply-side shocks and second round effects – including, for example, transportation fare hikes and minimum wage increases.” The BSP, it seems, will take its foot off the monetary gas pedal very cautiously.
Hike in interest rate means borrowers pay higher interest on their loans. Credit will be more difficult to come by, curtailment of bank lending, and loan demand may lead to reduce prices of commodities or planned price increases will stop.
In the US, the Fed remains firm with its plan of three rate cuts for this year. It raised its forecasts for its 2024 gross domestic product growth to 2.1 percent, up from 1.4 percent, which means possible stronger US economic growth in the near term. Fed Chairman Powell was not concerned about recent January and February higher-than-expected inflation reports. In his own words, “I think they have not changed the overall story which is that of inflation moving down gradually on a sometimes-bumpy road toward 2%.” He mentioned that their core consumer price index has been declining from a year-over-year reading of 6.6% to 3.8%.
On the other hand, the governing council of European Central Bank has decided to keep the three key ECB interest rates unchanged. Since January, ECB’s inflation has further declined. Inflation has been revised down, in particular, the 2024 contribution from energy prices. Although most measures underlying inflation have eased further, domestic price pressures remain high.
The Bank of Japan surprisingly raised interest rates this month, ending the country’s historic era of negative interest rates. The decision to increase rates from the previous minus 0.1% marked the first-rate hike in Japan in 17 years. Negative interest rates are used by central banks as a monetary policy to stimulate economic growth and combat deflation, not inflation.
In most countries today, global news report filtering out from the global media, indicated that economic growth is slowing and remains weak particularly from those countries that account for over 75 percent of global economic output.
According to Nobel Prize winner in economics, Michael Spence, the global economy will continue to be held back “by slow growth and reduced labor supply, the persistent threat of inflation, higher interest rates, shrinking public investments and elevated costs of capital for the foreseeable future.”
It has been said that the best-laid schemes of mice and men, often go awry; it has also been said, time and time again, there’s always hope, and indeed hope does spring eternal.
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Atty. Abelardo “Billy” Cortez is former national president of FINEX, the largest national organization of financial executives. He’s board director of IAFEI (International Association of Financial Executives Institutes) and independent board director at First Metro Investment Bank’s companies/subsidiaries (Metrobank Group). He’s an awardee of the Most Distinguished Bedan Alumnus in the field of banking and finance from San Beda College.