Cayman Islands, Caribbeanand International News
Tuesday, Mar 28, 2023

Why are central banks pushing to raise interest rates?

Why are central banks pushing to raise interest rates?

Banks are raising rates to bring down inflation but there is a risk to economic growth

Central banks around the world are pushing for the sharpest rise in interest rates in decades in response to soaring inflation.

With living costs across advanced economies rising at the fastest annual rate since the 1980s, the US Federal Reserve, Bank of England and European Central Bank are taking aggressive action to cool inflationary pressure.

However, there are risks for households and businesses as economic growth falters. Here are the reasons rising rates matter:

Why are central banks raising interest rates?

The impact of the Covid pandemic, supply chain disruption, worker shortages and Russia’s war in Ukraine driving up energy prices has fuelled a dramatic surge in the rate of inflation over recent months.

Across the OECD group of wealthy nations, inflation has reached 9.2% – the highest since 1988. Britain has the highest rate in the G7 group of rich countries – the UK, US, Canada, France, Italy, Germany and Japan – with the consumer price index (CPI) measure of inflation hitting 9% in April, the highest since 1982.

Central banks have mandates from their national governments to target low and stable inflation, typically of around 2%, while also bearing in mind the strength of the economy and outlook for jobs.

The Bank of England is widely expected to raise its base rate by 0.25 percentage points to 1.25% on Thursday for the fifth consecutive time.

The US Federal Reserve raised interest rates by 0.75 percentage points on Wednesday, to a range between 1.5% and 1.75%. It was the largest hike since 1994 in response to US inflation which soared to a 40-year high of 8.6% last month.

The European Central Bank plans to raise interest rates in July and September, after announcing that it would halt its quantitative easing bond-buying programme next month.

How does it help to bring down inflation?

Inflation measures the annual increase in average consumer prices for a basket of goods and services. Prices typically rise when either supply is constrained, or demand outstrips supply.

Higher rates make borrowing more expensive and encourage saving. When debt is costlier, this in turn can influence consumer demand for goods and services, as well as business investment and hiring intensions. This can help to cool inflation when demand is outstripping supply.

In addition, rising interest rates typically lead to a stronger currency on the foreign exchange markets. This helps to reduce the price of imported goods, and may be a key consideration for the Bank of England. With aggressive rate rises from the Fed, the American currency has strengthened to the highest level in two decades, while the pound has hit the lowest level against the dollar since the spread of the Covid pandemic in March 2020.

“The Bank will be keeping an eye on what’s happening with sterling,” said James Smith, an economist at ING. “When higher energy costs are priced in dollars, at the margin, a weaker pound is making that worse.”

Central banks also believe in the power of sending signals. By aggressively raising rates, central banks hope to demonstrate their commitment to bringing inflation back to their target. This is aimed to prevent expectations for persistently higher inflation, which could otherwise tempt workers to demand bigger pay rises or encourage companies to keep putting up their prices.

How does it affect you?

When the central bank raises interest rates, high street lenders pass them on to consumer and commercial borrowers and savers. While they’re typically slower to raise the interest paid on deposits, mortgage costs can rise quite quickly.

Those on standard variable rates – which track the Bank’s base rate – are the first to see the difference. However, most homeowners have fixed-rate mortgages. This means you won’t see higher costs until you come to the end of your term. This is one of the reasons central banks say it can take time for higher rates to counter inflation.

Renters are also likely to come under pressure, as buy-to-let landlords pass on higher borrowing costs to their tenants.

When the Bank raised interest rates in May by 0.25 percentage points to 1%, analysts at Hargreaves Lansdown estimated it would push mortgage payments up by over £40 per month.

Against a backdrop of rising interest rates, the Office for Budget Responsibility estimates household debt servicing costs to rise from £55bn to £83bn over the next two years.

What are the dangers?

Suppressing consumer demand runs the risk of squashing economic growth. With soaring living costs already threatening a spending downturn, this could exacerbate the risk of recession.

Andrew Bailey, the Bank’s governor, has warned that Threadneedle Street must tread a “narrow path” between responding to high inflation and weaker growth. In the US, some analysts expect the Fed could be forced to begin cutting interest rates again from as early as next year to counter recessionary risks.

Britain’s economy is forecast to slow to a standstill next year, with the country forecast to fall to the bottom of the OECD’s growth league table with the exception of Russia.

Beyond concerns over economic growth and inflation, there are questions over financial stability to consider.

Are governments at risk?

In the Eurozone, higher interest rates and the end of bond buying from the ECB has fuelled concerns over the fragmentation of the single currency bloc, reminiscent of the sovereign debt crisis in the middle of the last decade.

The central bank sought to allay concerns with an unscheduled meeting on Wednesday, after a sharp rise in Italian and Greek borrowing costs, as investors bet the reduction of economic stimulus could place pressure on highly-indebted governments.

Katharine Neiss, chief European economist at PGIM Fixed Income, said: “It remains an open question if the euro area economy can withstand interest rates significantly above 0%.”

Developing countries with high amounts of dollar borrowing could also be hit hard, as the higher interest rates from the Fed and a stronger American currency drive up their repayments.

Sri Lanka, faced with a political and economic crisis, has already defaulted on its debts, while analysts said countries including Ghana and Pakistan could also face difficulties.


Related Articles

Brand new security footage has just been released to the public showing the Active shooter Audrey Elizabeth Hale drove to Covenant Church School in her Honda Fit this morning, parked, and shot her way into the building
U.S. charges FTX's Bankman-Fried with paying $40 million bribe
Fallen 'Crypto King' Who Owes Millions to Investors Was Kidnapped and Tortured
Regulators blame social media for SVB's rapid collapse: 'Complete game changer'
AOC explains why she opposes banning TikTok
UK: Humza Yousaf replaces Nicola Sturgeon as SNP leader and first minister in Scotland
In a dramatic U-turn against His Government: Judicial Reform Legislation Must Be Halted, Says Israeli Defense Minister Yoav Gallant
Gordon Moore, a co-founder of Intel Corporation, died at 94
Powell: Silicon Valley Bank was an 'outlier'
Donald Trump arrested – Twitter goes wild with doctored pictures
NYPD is setting up barricades outside Manhattan Criminal Court ahead of Trump arrest.
Credit Suisse's Scandalous History Resulted in an Obvious Collapse - It's time for regulators who fail to do their job to be held accountable and serve as an example by being behind bars.
Home Secretary Suella Braverman tours potential migrant housing in Rwanda as asylum deal remains mired in legal challenges
Paris Rioting vs Macron anti democratic law
'Sexual Fantasy' Assignment At US School Outrages Parents
Credit Suisse to borrow $54 billion from Swiss central bank
Russian Hackers Preparing New Cyber Assault Against Ukraine
Jeremy Hunt insists his Budget will get young parents and over-50s back into work
If this was in Tehran, Moscow or Hong Kong
TRUMP: "Standing before you today, I am the only candidate who can make this promise: I will prevent World War III."
Mexican President Claims Mexico is Safer than the U.S.
A brief banking situation report
Lady bites police officer and gets instantly reaction
We are witnessing widespread bank fails and the president just gave a 5 min speech then walked off camera.
Donald Trump's asked by Tucker Carlson question on if the U.S. should support regime change in Russia?.
Silicon Valley Bank exec was Lehman Brothers CFO
In a potential last-ditch effort, HSBC is considering a rescue deal to save Silicon Valley Bank UK from insolvency
BBC Director General, Tim Davie, has apologized, but not resigned, yet, following the disruption of sports programmes over the weekend
Elon Musk Is Planning To Build A Town In Texas For His Employees
The Silicon Valley Bank’s collapse effect is spreading around the world, affecting startup companies across the globe
City officials in Berlin announced on Thursday that all swimmers at public pools will soon be allowed to swim topless
Fitness scam
Market Chaos as USDC Loses Peg to USD after $3.3 Billion Reserves Held by Silicon Valley Bank Closed.
Senator Tom Cotton: If the Mexican Government Won’t Stop Cartels from Killing Americans, Then U.S. Government Should
Banking regulators close SVB, the largest bank failure since the financial crisis
The unelected UK Prime Minister Rishi Sunak, an immigrant himself, defends new controversial crackdown on illegal migration
Man’s penis amputated by mistake after he’s wrongly diagnosed with a tumour
In a major snub to Downing Street's Silicon Valley dreams, UK chip giant Arm has dealt a serious blow to the government's economic strategy by opting for a US listing
It's the question on everyone's lips: could a four-day workweek be the future of employment?
Is Gold the Ultimate Safe Haven Asset in Times of Uncertainty?
Spain officials quit over trains that were too wide for tunnels...
Don Lemon, a CNN anchor, has provided a list of five areas that he believes the black community needs to address.
Hello. Here is our news digest from London.
Corruption and Influence Buying Uncovered in International Mainstream Media: Investigation Reveals Growing Disinformation Mercenaries
Givenchy Store in New York Robbed of $50,000 in Merchandise
European MP Clare Daly condemns US attack on Nord Stream
Former U.S. President Carter will spend his remaining time at home and receive hospice care instead of medication
Tucker Carlson called Trump a 'demonic force'
US Joins 15 NATO Nations in Largest Space Data Collection Initiative in History