When the economy slackens, central banks lower interest rates in an effort to boost growth and activity. When the economy is strong, rates rise. Rate reductions are intended to lower borrowing costs, which will increase consumer and business confidence and encourage investment and spending.

Several aspects of the economy are impacted by changes in interest rates, including property sales and mortgage rates, consumer credit and consumption, and stock market movements. As interest rates and inflation are directly correlated, rates must rise to keep inflation in check.

1. Rates of Interest and Borrowing

Falling interest rates have a direct effect on the bond market since falling yields make bonds from corporate to U.S. treasuries less appealing to prospective buyers. Bond prices fluctuate in the opposite direction of interest rates, so as rates drop, bond prices climb. Similarly, rising interest rates cause bonds to cost less, which hurts fixed-income investors. People are also less willing to borrow money or refinance their loans when interest rates increase since doing so is more expensive.

2. US National Debt

An increase in interest rates drives up the cost of borrowing for the US government, driving up the national debt as well as budget deficits. The Council for a Balanced Federal Budget projects a $12.7 trillion overall budget deficit from 2022 to 2031. The deficit would rise by $1 trillion with a 0.5 percentage point increase in rates.

In 2031, the national debt as a proportion of GDP is predicted to reach 107.5%. If interest rates rose by 50 basis points, this proportion would rise to 110.6% of GDP.

3. Savings

The rise in the prime rate results in higher rates for savings accounts, money markets, and certificate of deposits (CDs). In principle, that should promote savings among people and corporations since they can get a better return on their investments. The consequence, on the other hand, may be that someone who is heavily in debt would want to work towards paying off their debts in order to counterbalance the higher variable rates associated with credit cards, house loans, or other debt instruments.

4. Business Profits

The banking industry often experiences higher earnings as a result of rising interest rates since they can now profit more on the money they lend out. Yet a rate increase reduces profitability for the rest of the world’s businesses. That’s because expanding requires more expensive money. It can be bad news for a market that is now seeing a decline in earnings. As companies may get money with more affordable financing and make investments in their operations at a lower cost, declining interest rates should increase the earnings of many enterprises.

5. Rates on mortgages

Borrowers may rush to finalise a transaction for a fixed loan rate on a new house if there are signs of a rate increase. Yet, because interest rates are a major factor in mortgage rates, they often change more in lockstep with the yield on domestic 10-year Treasury notes. As a result, if interest rates decrease, so will the cost of a mortgage. It becomes more affordable to purchase a home when mortgage rates decline.