The central banks increase their key interest rates, also known as bank rate or base rate, in order to keep inflation under control. Expectations of a strengthening economy, increased consumer spending, robust employment levels and potential for rise in wages could lead to a hike in interest rates. Higher interest rates reduce disposable income, increase the cost of borrowing and rate of economic growth, thus limiting rise in inflation.
Even though rising rates do not affect stock prices directly, they affect consumers' ability to pay off debt or loans.
Rising rates also make credit cards and loans expensive, thereby affecting the disposable income of consumers.
How rising interest rates will affect the consumer?
Mortgage interest payments rise: Increase in interest rates lead to a rise in interest payment on variable mortgages, thereby affecting consumer spending. If you have a mortgage of $100,000, even a rise of 0.5% in interest rate translates to more than$40 per month. However, people with fixed-rate mortgage do not get affected by rise in interest rates.
Car loans become expensive:Increase in interest rates makes car loans more expensive. The interest that one has to pay on the car loan goes up with the rise in bank rates. Consumers with higher-interest car loans stand to benefit if the interest rate falls, depending on the duration of the loan and the amount of difference.
Rise in credit card rate: Most of the credit cards come with a variable annual percentage rate (APR), which is dependent on the bank rate. Thus, an increase in interest rate leads to a rise in the APR, which is the interest a consumer has to pay on the balance in his/her account.
Increase in student loan rates: Increase in bank rates also leads to a rise in the rate of student or education loans. A lower interest rate environment is always better when one plans to take a student loan.
Increased return on savings: One positive impact of rise in bank rates is increase in the interest rates that banks pay customers on their savings in savings account, fixed deposit, current account, etc. Even though higher rates are good news for savings, usually there are no significant changes in the amount of return one earns.
Lower disposable income: Since a rise in bank rates leads to an increase in the interest rates of all kinds of loans, which in turn increases the debt level of consumers, leaving them with a lower amount of disposable income to spend on consumer goods.
Affect on bottom lines of companies: As mentioned in the earlier point, rise in bank rates indirectly lead to lower disposable income for consumers, resulting in lower spending which has an effect on the bottom lines of companies. Reduced revenues or profits affect the stock price.
Impact on investors: Increase in bank rates has a significant impact on the portfolio of income investors, particularly those who favor bonds. Rise in interest rates leads to a decline in bond prices. Bond yields are also impacted by rising rates, with substantial effects seen on long-term bonds that have a maturity period of 10-30 years.
Lower confidence:Increase in bank rates affect both business and consumer confidence. A rising interest rate environment discourages investment and lowers companies and consumers' willingness to purchase risky investments.