How does raising interest rates by the central bank affect the economy?

In the face of inflation that we haven’t seen in nearly 40 years, central banks in the US and the Eurozone are starting to raise their rates, with tangible consequences for the real economy.

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This shift in monetary policy, with the Federal Reserve on Wednesday announcing a 0.75 percentage point rate hike, the largest since 1994, will have implications for both individuals and businesses, but also for fragile countries.


More expensive loans

For borrowers, this means an increase in the cost of credit, for example to buy a house.

“Real estate prices are already going up and this should increase,” explains Eric Dorr, Director of Economic Studies at the IESEG School of Management.

Concretely, higher interest rates for central banks increases the cost of financing for banks. The latter passes it on to their customers, companies or consumers who seek to borrow.

For those who already have a loan, on the other hand, the situation will differ from country to country: “In France, there is a high preference for fixed rates, so they do not develop according to the overall rates of development. The Iberian Peninsula prefers variable rates more easily, and the risks will be higher there And it really caused concern,” explains Mr. Dor.

Party savers

Savers have everything to gain from higher prices, which makes returns for financial products, such as life insurance or savings accounts, more attractive.

The rate of the latter is calculated according to the rate at which banks lend to themselves, and the development of inflation.

“If the revaluation were done today, the suggested rate would be 1.7%,” Eric Dorr explains, up from 1% last February. The next increase could come on August 1.

Listen to Mario Dumont’s interview with Daniel German on QUB Radio:

More exports, more expensive imports

The effects of raising interest rates vary depending on which central bank initiates these increases. Decisions made by the Federal Reserve (the Federal Reserve) are especially under scrutiny: they start earlier and are much clearer than those decided by the European Central Bank, the first of which is supposed to take place in July.

“The Fed acted earlier and stronger, halted its asset purchases and even started shrinking its balance sheet, unlike the ECB,” Eric Dorr said.

As a result, the dollar becomes more profitable and becomes more expensive against other currencies such as the euro.

Then products denominated in US currency become more expensive, which relates to oil and almost all raw materials, with the main effect on inflation outside the US and therefore higher prices in stores or at the pump.

But this decline in the euro against the dollar is beneficial to exporting companies, especially to the United States.

In total, “there is a decrease in purchasing power, but with an increase in exports, this makes it possible to protect or even create jobs,” recalls Mr. Dorr.

In some export sectors, such as luxury or the aviation industry, a decline in the euro will therefore have a positive impact on financial results.

Bigger risks outside Europe

Although European countries are generally protected from the effects of such rate hikes, particularly those of the Federal Reserve, this is not the case for emerging or poorer countries, already weakened by the consequences of the health crisis or war in Ukraine and soaring commodity prices. . and energy prices.

As with the euro, higher Fed rates automatically drive the dollar up against emerging currencies, bolstering already high inflation. It also withdraws US Treasuries, then it becomes more profitable and safer for investors.

“For countries that are already in difficulty, such as Turkey or Brazil, but even Argentina or Sri Lanka, they are not welcome at all, because they raise prices while causing capital to flow from these countries to countries in particular” making it more complicated to finance their economy, Eric Dorr worries. With the risk of destabilizing them a little more.

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