The past two years have seen record low-interest rates due to the pandemic. But with that, we’ve also seen records level of inflation which now have most central banks beginning to increase the rates again. But will they follow through with their current plans? Or will decreased economic growth on top of struggling households hold the current interest rate paths back? Let’s explore!
Most western economies are expecting increased interest rates after 2 years of record lows, but will it go as high as indicated? image source
Increased mortgages, a trap?
For many people, the pandemic’s record low-interest rates have provided a unique opportunity to get into real estate as money has been virtually “free”. However, this can also become an ugly trap for many who may have not taken into account the effects of interest rates returning to normal. Of all the people who will have maxed out their mortgage in pursuit of their dream house, how many will have found the time to analyze how their finances would be affected by an interest rate closer to 2.5%, or a mortgage rate of 4% compared to the sub 2% that they may have grown used to? Even if it doesn’t spell financial ruin, how will that increase in monthly interest affect the rest of their spending? Will they still be able to go out for dinner once per week, refurbish the bathroom, and take an adventurous holiday as planned?
Although there are many indicators showing a strong economy, which I think makes sense as a crisis tends to result in companies being forced to become more efficient in many ways, an interest rate that is increased very quickly can quickly put a dent in it. Many central banks have already performed up to three rate hikes, with Norway’s now being at 0.75% from its all-time low of 0% during the pandemic (while the European Central bank is keeping a negative rate). Here, the new head of the central bank is also warning of 7 more increases by the end of 2024, which would take the rate up to 2.5%. Although these may still seem like small percentages, they will mean a rough doubling of monthly expenses to pay off the interest on loans from today’s levels.
Other increased costs of living
Rising interest rates are not the only added expenditure for households worldwide. Record high inflation, which the interest rises are meant to address, has predominantly affected the prices of electricity, gas, and food, all of which make up key elements in a household’s monthly budget. Much of this has been completely unrelated to the low-interest rates, with Russia’s war against Ukraine having a big impact on energy prices, while also causing other ripple effects on the economy, while the pandemic has still left its mark on global supply chains.
The question then is whether this cocktail of added expenses will significantly impact economic growth. At this rate, it seems unthinkable that it won’t be given how important all these cost elements, including as well as people’s wages which are also likely to increase more than normal due to demand from labor unions, are to businesses everywhere.
The consequences
While the proposed interest paths make sense from the point of view of combating inflation and making up for two years of near-zero interests, they may be halted by economic stagnation. Myself, I think it is unlikely that the central banks will follow through with their current plans. Sure, it will likely do it for a few months or maybe even a year, but once rates have been brought up an additional percentage point from today’s levels I believe that caution will kick in.
It will also be interesting to see the effects on growth stocks and businesses that need to take up loans to fund their development or growth. Given that the markets have now priced in several hikes, a comparably prolonged period of relatively low-interest rates, could have a big impact on their valuation.
On a personal finance side, the recent price hikes and increased rate-path have had many people start asking themselves if they should lock in their mortgages to a fixed interest loan. However, as banks have already priced in several rate hikes, and my own read that it will be difficult for the central banks to follow through as aggressively as it has warned, I doubt this will make for a good decision financially.
In any case, there are many things here to consider. My gut feeling tells me that there will be a lot of bleeding for the lower middle class who have to face higher interest rates, higher gas prices, and higher costs of living all at the same time. This, in turn, will result in pressure on the central banks to relax the interest paths a bit, which in turn will benefit growth companies. That said, we live in a time where disruptive events have made it impossible to predict the long term, as it is constantly bombarded with other unusual factors like pandemics and wars. But given the current conditions, this is at least where I sense that we’re going.
Or what do you think?