Interest Rate Drivers - InterestRate.co.uk

Interest Rate Drivers

The interest rate charged by banks is determined by a number of factors, such as the state of the economy. A country’s central bank sets the interest rate, which each bank use to determine the APR range they offer. When the central bank sets interest rates at a high level, the cost of debt rises. When the cost of debt is high, it discourages people from borrowing and slows consumer demand. Also, interest rates tend to rise with inflation.

Fast Fact: The current interest rate for a 30-year mortgage is around 4%, according to Bank of America; in 1981, according to The Street, the 30-year fixed mortgage rate was 18.5%.

Related article:   Why is my mortgage interest rate higher than the bank rate?

To combat inflation, banks may set higher reserve requirements, tight money supply ensues, or there is greater demand for credit. In a high-interest rate economy, people resort to saving their money since they receive more from the savings rate. The stock market suffers since investors would rather take advantage of the higher rate from savings than invest in the stock market with lower returns. Businesses also have limited access to capital funding through debt, which leads to economic contraction.

Economies are often stimulated during periods of low-interest rates because borrowers have access to loans at inexpensive rates. Since interest rates on savings are low, businesses and individuals are more likely to spend and purchase riskier investment vehicles such as stocks. This spending fuels the economy and provides an injection to capital markets leading to economic expansion. While governments prefer lower interest rates, a reason why the U.K. may never switch to the euro, they eventually lead to market disequilibrium where demand exceeds supply causing inflation. When inflation occurs, interest rates increase, which may relate to Walras’ law.

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