Banks around the world are raising interest rates to control inflation. What does this mean for you?

The US, UK and EU are raising interest rates to combat the rising tide of inflation, attempting to successfully navigate a delicate balancing act of reducing consumer spending, but not slowing the economy too much.

On Thursday, the Bank of England made headlines after announcing it will further raise interest rates to 1.75 per cent. Last month, the European Central Bank raised interest rates for the first time in 11 years to 0.0 per cent as it sharply reversed policy to combat the tide of inflation.

The US’ Federal Reserve also raised rates last month by three-quarter points to the 2.25 – 2.5 per cent range.

Europe and the US are both experiencing rapid inflation, coming from supply shocks and bottlenecks resulting in fewer products on the market to keep up with post-pandemic demand, as well as Russia’s war in Ukraine wreaking havoc on global energy prices – both being key source markets for natural gas and crude oil.

Ukraine’s status as a key wheat and grain exporter also sharply raised food prices, hitting consumers with price hikes on several essential items.

What’s the connection between interest rates and inflation?

As described above, many companies and organisations have had serious issues with stocking enough goods or raw materials to manufacture their goods due to shipping and supply chain disruptions (China is still pursuing lockdowns due to its zero-COVID policy).

One way to control prices is to raise the cost of borrowing, in other words, interest rates. This encourages consumers to borrow less, and in turn spend less. It also encourages people to save more of their cash.

Policy makers must be careful, however, as slowing the economy too much can herald in a recession, which commentators believe is already happening in the UK and US.

What’s the impact of raising interest rates on the public?

Home loans

According to a 2020 National Statistics Office report, 79 per cent of Maltese households were owned. Of these, 43 per cent were subject to some form of mortgage.

When central authorities increase interest rates, or the cost of borrowing, those mortgage payers who are not on fixed interest rate loans will see their monthly repayments go up.

Credit cards and other loans

Interest rates can also impact the interest charged on services like credit cards and car loans.

Savings

Interest rates also determine the amount of interest payments deposit holders will receive on their deposits. Increases in interest rates will make savings more attractive, as there is a higher return from bank interest rate payments, thus encouraging savings.

On the other hand, a cut in interest rates reduce rewards of saving and is used to discourage saving and increase spending.