Who is affected by high interest rates?
Higher interest rates tend to negatively affect earnings and stock prices (often with the exception of the financial sector). Changes in the interest rate tend to impact the stock market quickly but often have a lagged effect on other key economic sectors such as mortgages and auto loans.
Rising rates are a risk for banks, even though many benefit by collecting higher interest rates from borrowers while keeping deposit rates low. Loan losses may also increase as both consumers and businesses now face higher borrowing costs—especially if they lose jobs or business revenues.
When we change our interest rate, banks will usually change the interest rates for both savers and borrowers. But, to cover their costs, banks normally pay less to savers than they charge to borrowers. So there's usually a gap between rates on savings and loans.
For example, if you want to buy something large, like a car, it will cost you more as car prices will be higher. And if you need a loan to finance your car, you will have to take out a higher loan and pay more interests on it. You may as well face more difficulties in obtaining a loan from a bank and in repaying it.
Higher interest rates have gotten a bad rap, but over the long term, they may provide more income for savers and help investors allocate capital more efficiently. In a higher-rate environment, equity investors can seek opportunities in value-oriented and defensive sectors as well as international stocks.
Inflation allows borrowers to pay lenders back with money worth less than when it was originally borrowed, which benefits borrowers. When inflation causes higher prices, the demand for credit increases, raising interest rates, which benefits lenders.
Rising prices threaten to hit the poorest the hardest, but at the same time higher interest rates can hit families with mortgages and consumer loans; both of which could fuel a recession that would again make life harder for lower income households.
Home mortgages and personal loans
Because fixed-rate mortgages have the interest rate locked in, anyone looking to buy or refinance will benefit from the sustained lower rates. This is true for all fixed-rate financial products, including personal loans and car loans.
The interest rate for each different type of loan, however, depends on the credit risk, time, tax considerations (particularly in the U.S.), and convertibility of the particular loan.
A higher interest rate environment can present challenges for the economy, which may slow business activity. This could potentially result in lower revenues and earnings for a corporation, which could be reflected in a lower stock price.
How do interest rates affect consumers?
Interest rates affect the cost of borrowing money over time, and so lower interest rates make borrowing cheaper—allowing people to spend and invest more freely. Increasing rates, on the other hand, make borrowing more costly and can reign in spending in favor of saving.
The years 2022 and 2023 bucked the usual trend a bit. High interest rates typically cause the economy to crash, after which interest rates are lowered to stimulate activity again. However, things have played out slightly differently during the COVID-19-induced economic downturn and the following recovery.
If you're wondering what happens when interest rates rise, the answer depends on the portion of your finances. Rising interest rates typically make all debt more expensive, while also creating higher income for savers. Stocks, bonds and real estate may also decrease in value with higher rates.
Just as Congress and the president control fiscal policy, the Federal Reserve System dominates monetary policy, the control of the supply and cost of money.
With higher interest rates, there will be lower demand for goods and services, and the prices for those goods and services should fall.
When the central bank increases interest rates, borrowing becomes more expensive. In this environment, both consumers and businesses might think twice about taking out loans for major purchases or investments. This slows down spending, typically lowering overall demand and hopefully reducing inflation.
Former Treasury Secretary Lawrence Summers recently warned that interest rates on Treasury bills could remain well above 3 percent through 2030, after averaging only 1.5 percent in the last decade. Harvard economist Kenneth Rogoff declared in December that “higher interest rates are here to stay.”
Inflation Lowers Debt Service Costs
While new borrowers are likely to face higher interest rates when inflation rises, those with fixed-rate mortgages and other loans get the benefit of repaying these with inflated money, lowering their debt service costs after adjusting for inflation.
Some of the worst investments during high inflation are retail, technology, and durable goods because spending in these areas tends to drop.
The moneylenders who get fixed repayments are also negatively affected because the time value of money decreases with inflation. So the money they get has a lower value. The people having physical assets are positively affected by inflation because they can retain the asset's value.
How do you fix inflation?
Monetary policy primarily involves changing interest rates to control inflation. Governments through fiscal policy, however, can assist in fighting inflation. Governments can reduce spending and increase taxes as a way to help reduce inflation.
Higher interest rates typically slow down the economy since it costs more for consumers and businesses to borrow money. But while higher interest rates can make it more expensive to borrow and could hamper overall economic growth, there are also some benefits.
- High-yield investments.
- Bond ETFs.
- Preferred stock.
- REITs.
- Housing stocks.
High-yield savings accounts may not make you rich, but you'll automatically earn much more than you would with a lower rate option. Use a savings calculator to determine what your bank balance can be with different APYs and see how your money could grow.
Investors should consider bonds a worthy component of their portfolios at current interest-rate levels, and they should consider adding more should rates jump higher. Value stocks benefit from higher rates, while growth stocks trend in the opposite direction.
