How do interest rates affect the real economy?

• Central banks in the United States, eurozone and UK are raising interest rates.
• The US Federal Reserve announced the most aggressive interest rate increase in nearly 30 years.
• Higher rates affect the cost of borrowing for banks, which then pass those costs onto businesses.

In order to curb inflation, central banks in the United States, the eurozone, and the United Kingdom are raising interest rates.

The monetary policy shift will have a tangible impact on the real economy for consumers and businesses in these countries and beyond, including countries with considerably more unstable economies.

The US Federal Reserve announced the most aggressive interest rate increase in nearly 30 years, raising the benchmark borrowing rate by 0.75 percentage points on Wednesday.

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And the Bank of England was expected on Thursday to raise its key interest rate for a fifth straight time.

– Higher borrowing costs –

Higher central bank interest rates affect the cost of borrowing for banks, which then pass those costs onto businesses, consumers and even governments.

That means higher borrowing costs, such as for buying a house.

“Mortgage rates are already rising, and that is likely to accelerate,” said Eric Dor, head of economic studies at France’s IESEG School of Management.

Higher borrowing costs eventually slow borrowing and thus economic activity. This should eventually slow inflation, which is the objective of central banks in raising interest rates.

Those who have to borrow face higher costs, but those with fixed rates on long-term loans (as is the case for mortgage loans in many countries) stand to benefit as the value of the repayments has diminished in real terms.

– Savers celebrate –

Those who have savings also stand to gain from rising interest rates. However, most savings rates still propose rates considerably lower than the inflation rate.

– Currency values and trade –

Higher rates are affecting the value of currencies.

The dollar has been gaining in value against the euro as the US Federal Reserve has already begun raising interest rates, while the European Central Bank will only begin doing so in July.

The strong dollar will reduce the cost of imports for US consumers while increasing the cost of US exports for international buyers. This could reduce jobs.

It’s the inverse for the eurozone and the United Kingdom, whose currencies have weakened versus the dollar. Imports are more expensive, particularly oil, which is priced in dollars. Exports are enhanced since they are less expensive in dollars. A surge in exports could assist to sustain jobs.

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