Interest Rates

28 December 2020, 08:16

Every time the chairman of the FOMC, Janet Yellen, gives a speech everybody is playing the guessing game trying to figure out what’s going to happen with the interest rates.

Interest rate can be defined as;

‘The cost of borrowing money expressed as a % of loan value’

Understanding Interest rates is important when talking about factors such as the money supply or inflation because central banks use the manipulation of interest rates to control the money supply and combat inflation.

You might be wondering why this is important to you, well; changes in interest rate cause changes in the economy and changes in the economy affect your trading.

Example: Increasing the interest rates

This effectively makes borrowing money less easy and as a result the amount that people spend goes down.  The decrease in expenditure means that the demand for many goods goes down, and as a result, their price will also decrease.

The central bank will often increase interest rates when they fear the economy is “inflamed” – they make borrowing less easy to reduce expenditure and cool the economy down in order to avoid inflation.

Example: Decreasing the interest rates

This effectively allows us to borrow money more easily and as a result the amount that people spend goes up. The increased expenditure means that there is also an increase in the demand for many goods, and as the demand for these goods increases so too will their prices.

The central bank will lower interest rates when they feel as though the economy is facing a potential recession, interest rates will be reduced to encourage spending and promote the growth of the economy.