Entries Tagged 'interest-rates' ↓
January 8th, 2008 — interest-rates
Readers Question: What is Amortisation ?
Amoririsation is the running down of a loan through regular payments. A good example is a capital repayment mortgage. In this case the homeowner pays monthly installments paying both interest on the loan and also capital repayments. This means that after 30 years the loan will be paid off.
The opposite of amortisation is an interest only mortgage. With an interest only mortgage, only interest payments are made. This means that the capital debt of the loan remains. Usually, with an interest only mortgage the borrower is required to find an alternative investment plan to be able to pay off the debt.
See also:
January 8th, 2008 — interest-rates
The interest rate cycle is closely related to the economic or trade cycle.
Interest rates are the main mechanism of influencing economic activity. For example, in the past few months retail activity in the UK has slowed down, therefore, many have been calling for interest rate cuts to stimulate domestic demand.
Since 1997, UK interest rates have been fairly steady, the interest rate cycle has been less volatile. However in the 1980s, under the Thatcher government the interest rate was much more volatile due to the economy being subject to periods of boom and bust.
Diagram of Interest Rates in the UK
Source: BBC website - Thatcher years in pictures
Note the two periods of very high interest rates in 1980 (17%) and 1990 (15%) were followed by recessions.
On both occassions interest rates were increased to reduce inflationary pressure. In 1990, interest rates were also increased to protect the value of the Pound Sterling in the Exchange Rate mechanism. Continue reading →
January 4th, 2008 — interest-rates
Gross interest rate This is the total interest payable before any deductions such as tax and charges. For example the gross interest rate on a savings account may be 4.25%
Net Interest Rate. This is the total interest payable after any deductions. For example in the UK, the net interest rate will be the gross interest rate – basic rate of income tax. Therefore, if the gross rate is 4.25%, the net rate will be 3.40%.
Gross AER. This is the Gross Annual Equivalent rate. This applies to all accounts where interest rates are paid more frequently than once a year. The significance of this is that if you are paid interest every month, you have a chance to earn interest on the interest payments you gain in the first month. If interest is calculated daily the cumulative benefit will be greatest. Therefore, the Gross AER, will be higher than the gross interest rate. Typically interest is credited monthly, quarterly or in rare cases daily.
December 9th, 2007 — interest-rates
Readers Question: What is the effect for increased interest rate on country and depositors
I have answered this question a few times before:
I don’t want to repeat what I have already written so will just make a few ‘new’ observations.
Higher interest rates increase the cost of borrowing and make it more attractive to save. This is likely to reduce consumption and reduce the rate of economic growth.
However, there is also an income effect of higher interest rates. As interest rates increase, savers (people who have deposits) will see an increase in interest rate payments. - Basically, saving has a higher reward. Therefore, savers see an increase in disposable income this could actually cause an increase in consumption.
However, in the UK, the savings ratio is very low. The UK has high levels of personal debt. Therefore an increase in interest rates will reduce the disposable income of people with mortgages and debt. This will outweigh the increased incomes from depositors. In the UK, higher interest rates have a particularly big effect in reducing consumer spending because of the size of mortgages.
Generally, interest rates are used to control inflation. Higher rates are used to reduce inflationary pressures. The UK economy is particularly sensitive to interest rate changes.
Higher interest rates also make it more attractive to save money in the UK, as opposed to other countries. Therefore, higher rates will cause ‘hot money flows’ and may cause the value of the £ to rise.
December 5th, 2007 — interest-rates
Readers Question: In general what do commercial banks receive their higher interest rates from?
I’m afraid I don’t really understand this question. But, I will make these points.
Commercial banks will lend money at a higher rate than they pay to savers. This difference in interest rates enable them to make a profit. For example, if you went to a commercial bank such as Natwest, Halifax or HSBC, they may charge you 7-8% for a loan. These tend to be the highest interest rates commercial banks will charge. If, however, you borrowed on a credit card, the interest rate may be 16%.
Interest rates on savings can vary from practically 0% to 4-5%. For the highest interest rate, savers will probably have to commit to saving for a certain length of time. They may have to give a months notice before withdrawing the money.
Commercial banks, borrow from the Bank of England. This is because the Bank of England acts as lender of last resort. This interest rate is known as the Repo rate or ‘base rate’
December 3rd, 2007 — interest-rates
I’ve been studying economics for 13 years and I still get confused at the bewildering array of interest rates. Basically, interest rates can range from anywhere between 0% and 2,316%
The most important rate is the base rate (sometimes referred to as the repo rate). This is the rate set by the Bank of England. (In US by the Federal Reserve). This is important because it determines the rate at which banks borrow money from the Bank of England. Therefore, if the Bank of England changes the base rate the commercial banks, like Natwest and HSBC will alter there interest rates accordingly.
- Current account rates. This tend to be low, e.g. 1%. This is because you can access the money at any time. Therefore, for these account, the banks have to keep a greater % of cash in the bank for when people wish to withdraw money.
- Savings Account rates. These tend to be higher e.g. 4%. The banks are willing to pay higher interest rates because they are less likely to have deposits withdrawn. Continue reading →
November 1st, 2007 — interest-rates
October 31st, 2007, the US federal reserve cut interest rates by a quarter of a point to 4.5%. This follows on from a half point cut, a few weeks ago.
The logic for falling interest rates in the US includes:
- Weak Housing Market - House prices falling, sales plummeting. This negative wealth effect is likely to reduce consumer spending and weaken inflationary pressures.
- Strength of Oil Prices - The US economy is heavily dependent on oil. Higher oil prices, effectively reduce disposable income
- Concerns over Credit Markets. Many financial institutions have been burnt by the sub prime mortgage crisis in America. Lack of credit will harm the economy.
- Fall In Consumer Confidence. The combined effect of these things is to reduce consumer confidence
- Inflation is close to Target
Concerns over Rising Interest Rates
Despite these reasons, there are also factors which may prevent future interest rate falls. These are arguments already have some support. ( Not everyone on the Fed voted in favour of a cut.)
Inflationary pressures still there. There are some reasons to suggest inflation may not be as dormant as people would like to believe. Rising oil prices, rising commodities and the weak dollar, can all contribute to inflation in 2008. This would make future interest rate cuts unlikely.
Weakness of the economy over exaggerated. It is often the nature of the media to exaggerate the impact of the slowdown in the housing market. A slowdown in the Housing market need not necessarily cause a recession. Output in Summer grew at 3.9%. This is remarkably high, given the adverse publicity from the housing crisis.
Personally, I feel that US interest rates may not fall for a while. Although I am a little mystified how the economy can be growing at 3.9% when the housing market is in such dire straights. I would have expected the fall in consumer spending to have had a bigger impact on growth. Maybe in 2008, it will.
At the moment, exporters are benefitting from the weak dollar. At least the US current account deficit should be falling in 2008.
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