Understand the impact of rising interest rates on the global economy

The Fed is not alone in taking such a step. The central banks of the UK, Canada and Brazil have also changed their monetary policy to combat rising inflation.

“The Fed has raised its fees by half a percentage point”. The ad probably seemed vague and distant to some of the general public. However, this decision by the US Federal Reserve has consequences for all sectors of the world economy.

The “Fed”, the central bank of the United States, is not the only one to take such a step. The central banks of the UK, Canada and Poland, to name a few examples, have changed their monetary policy to combat rising inflation.

For now, the European Central Bank (ECB) has postponed this decision, despite having already started to withdraw its support to the economy.

This shift marks the end of the era of free or near-free money, after years of very low interest rates that allowed states, businesses and households to borrow cheaply.

Central bank instrument

Interest rates are the main instruments of central banks. These are rates applied to deposits or loans from commercial banks.

“Indirectly, they lower or raise the fees that banks will charge their customers,” explains Éric Dor, director of economic studies at the IESEG School of Management.

They also influence bond market rates: States, which have an impact on corporate interest rates, soared. For example, the 10-year US Treasury bond rate has doubled in five months and is currently at 3%. France’s went from zero to 1.5% in the same period.

While the ECB has yet to take the step of raising it, “long-term rates are going up in Europe because the markets already anticipate” that this will happen, continues Dor.

Raising Rates: Why?

“Central banks raise their rates when they want to fight excessive inflation due to very high demand,” says this expert.

Currently, companies raise their prices to compensate for supply difficulties and the increase in some raw materials.

In turn, households that saved during the Covid-19 pandemic may spend more, causing prices to rise.

It is difficult to predict how long the increase in interest rates will have an effect on consumption, but the purchasing power of families “has already been reduced with inflation and the rise in consumer credit rates will put a brake on their spending”, anticipates Maximilien Monot, fund manager at Monocle AM.

The situation will also change for home loans. Rates have already started to rise in the United States, driven by strong demand from individuals and difficulties for construction companies to complete their projects due to global supply problems.

Brake on investments

If taking on debt is no longer free, companies will have to think twice about doing it. Initially, the impact on the accounts will be felt at the time of refinancing the debts contracted at zero rate.

For new loans, the company must present a project with a higher level of profitability to guarantee its ability to pay. Banks and investors will be more demanding before providing their financial support.

Mechanically, “investments and innovation will slow down due to the debt capacity”, warns Maximilien Monot.

However, there is not much concern in the short term, as these effects will be felt in companies within a year.

Recession risk

Between a drop in consumption – which will reduce company sales -, reduced investments, still very high inflation and less accessible loans for states and companies, Éric Dor believes that “the risk of recession is strong”.

It is the end of the “whatever it takes” of the States, since now helping companies will cost much more, it is an additional brake and can lead to the bankruptcy of the “zombie companies” that have lived off the perfusion for years.

Financial markets are already showing signs of fear of a wave of corporate defaults.

Source: AFP