interest-rates

Effect of lower interest rates

Effect of lower interest rates

A look at the economic effects of a cut in the Central Bank base rate. Summary: Lower interest rates make it cheaper to borrow. This tends to encourage spending and investment. This leads to higher aggregate demand (AD) and economic growth. This increase in AD may also cause inflationary pressures. In theory, lower interest rates will: Reduce the incentive to save. Lower interest rates give a smaller return from saving. This lower incentive to save will encourage consumers to spend rather than hold onto money. Cheaper borrowing costs. Lower interest rates make…

Winners and losers from low interest rates

Winners and losers from low interest rates

With UK interest rates close to zero, who benefits from low interest rates? In summary, the main effects of low interest rates are: Savers will get lower interest payments on their savings. Borrowers, especially mortgage owners ,will see lower interest payments on their debt, increasing discretionary income. The government can borrow from the private sector at a lower interest rate, reducing interest costs on public sector debt. Banks find it harder to be profitable and attract deposits. This can adversely affect the quantity of loans. Therefore, although it is cheap…

The natural rate of interest

The natural rate of interest

The natural rate of interest is the interest rate consistent with maintaining economic growth at its trend rate and stable inflation. Another definition of the natural rate of interest is: “the real interest rate consistent with real GDP equalling its potential level (potential GDP) in the absence of transitory shocks to demand. (FR) In other words the natural rate of interest is that interest rate which causes neither overheating (boom) or lack of demand (recession). Monetary policy is essentially concerned with finding the natural rate – because that will give…

Who benefits from low interest rates?

Who benefits from low interest rates?

When interest rates were cut to 0.5% in March 2009, few would have predicted that interest rates would have stayed low in UK, US and the Eurozone for so long. Interest rates have stayed at zero for several years – defying several predictions that they will rise soon. Who benefits from low interest rates and who loses out? Beneficiaries of low interest rates 1. Homeowners with variable mortgages The big winners from a period of low interest rates are homeowners who are paying a variable mortgage. Firstly, low interest rates will lead to lower…

Base rates and bank interest rates

Base rates and bank interest rates

The Bank of England set the base rate. This is the rate at which they charge commercial banks to borrow from the Bank of England. In normal economic circumstances, this base rate will influence all the interest rates set by other banks and financial institutions. If the Bank of England cut the base rate, you would expect banks to also cut their mortgage and lending rates. If the Bank of England put up the base rate, you would expect banks to increase their mortgage rates.

Real interest rates

Real interest rates

The real interest rate is the nominal interest rate – inflation rate. For example, if the Bank of England set base rates of 5.5% and the CPI inflation rate is 3.4%. Then the real interest rates is said to be 2.1% A higher real interest rate is good for savers and bad for borrowers. Note, even if nominal interest rates were high e.g. 11%, savers would see a decline in their real value of money if inflation was 12%. This is why the real interest rate is important Real interest rates can be…

Are UK house price rises sustainable or are we heading for a crash?

Are UK house price rises sustainable or are we heading for a crash?

Readers comment on – House prices stats Excuse me for pointing out the obvious, but why are those ratios (House price to incomes) unsustainable if interest rates stay low? It’s the ratio of house-price-multiplied-by-interest-rate to earnings that determines affordability, not ratio of house price to earnings. If rates fall as prices rise, then the first ratio remains affordable. If earnings rise, the ratio remains affordable. Interest rates have been on a downward trend for 25 years and inflation has been tamed, there’s no reason for that trend to change..

Tapering and the effect on interest rates

Tapering and the effect on interest rates

Readers Question: As the FED is talking about tapering and at the same time  keeping interest  rate low. How can they both go together? Tapering will raise yield as bond prices go down in  absence of any freak buying. And interest rate  will chase yield this causes interest rate to climb up. Fed Tapering means that the Federal Reserve will begin to stop buying bonds, and no longer continue to create money and buy bonds. This tapering could also be seen as a preliminary to reversing quantitative easing and selling…