This year, about 90 central banks have hiked interest rates, with half of them raising rates by at least 75 basis points all at once. Many did it multiple times, in what Bank of America Corp. senior economist Ethan Harris describes as a “competition to see who can hike faster.”
As a result, monetary policy has been tightened broadly for the first time in 15 years, signalling a major break from the cheap-money period set in by the 2008 financial crisis, which numerous economists and investors had come to see as the new normal. According to JPMorgan Chase & Co., the current quarter will witness the most rate rises by major central banks since 1980, and it won’t end there.
What does a hike in interest rate mean?
The hike in interest rates, which the banks will pick up and eventually pass on to customers means that loan rates will increase. Interest rates on home, personal, car and gold loans will increase following the increase in benchmark rates.
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The repo rate is the rate at which commercial banks borrow money from the central bank to maintain liquidity. It is one of the primary measures to control inflation.
A higher repo rate leads to a higher cost of borrowing. If inflation levels are high, which it is currently, the central bank hikes the repo rate to make borrowing expensive which will affect businesses and industries and slow down investment. This will hurt economic growth but help control inflation. An increase in CRR also makes the loans a costly affair.
According to SBI Ecowrap, the increase in repo rate and CRR would increase the marginal cost of funds-based lending rate (MCLR) marginally. If banks increase deposit rates, then the cost of funds (CoF) will also increase, which will push MCLR as well.
Why are interest rates are being increased?
Interest rates are increased to control rising inflation, which is currently at all-time high levels as supply chains are disrupted due to the Russia-Ukraine war and the Covid-19 pandemic. High key rates make borrowing a costly affair which will limit the money supply for the purchase of riskier assets.
High rates slow down consumer and business spending, especially on expensive items, such as properties and other luxury goods. It reverses the wealth effect and also makes banks more careful about lending.
Interest rates and inflation move in a similar direction. If inflation is rising, interest rates are increased. But economic slowdown lowers the inflation rate and may encourage rate cuts to revive growth.