Why rates are being hiked globally, and what it means

Why rates are being hiked globally, and what it means

Not only RBI and the US Federal Reserve, Hong Kong too increased its rates and UK is scheduled to increase it on Thursday. 

As inflationary pressures sustain amid uncertain geopolitical tensions, central banks or monetary authorities of various countries have resorted to an increase in benchmark interest rates. 

To begin with, India's central bank hiked its key lending rate or the repo rate on Wednesday by 40 bps to 4.40 per cent. It also hiked CRR or cash reserve ratio by 50 basis points to 4.5 per cent from May 21. The RBI reasoned that “near-term inflation outlook are rapidly materialising” and that they expect inflation to rule at elevated levels.

Soon after, the US Federal Reserve raised its benchmark interest rate by half a percentage point, the biggest jump in 22 years. The Fed too stated that inflation "remains elevated" due to the war in Ukraine and new coronavirus lockdowns in China threatening to keep pressure high.

Not only the US Federal Reserve, Hong Kong too increased its rates and UK is scheduled to increase it on Thursday. 

Hong Kong’s monetary authority too, keeping in line with the US Fed, increased its benchmark interest rates to 1.25 per cent from 0.75 per cent. 

UK's central bank Bank of England is also expected to raise interest rates on Thursday for the fourth time since December as it tries to fight rising inflation. Last month Governor Andrew Bailey said he and his colleagues were walking a "very tight line" to steer the world's fifth-biggest economy through the global post-pandemic inflation surge which has been aggravated by Russia's invasion of Ukraine. On the back of this, BoE is expected to increase rates by a quarter-point. 

What does it mean?

The increase in rates, which the banks will pick up and subsequently pass on to customers, means that loan rates will increase. This means that home, car, personal, and gold loan rates – all that are linked to the external benchmark – will increase following the rate hikes. 

Repo rates refer to the rate at which commercial banks borrow money from the central bank – in India’s case, the RBI – to maintain liquidity. It is one of the most important means to control inflation. 

A higher repo rate means a higher cost of borrowing. If inflation levels are high – which it is currently – the RBI will increase the repo rate to make borrowing a costly affair which will impact businesses and industries and slow down investment. This will likely impact the growth of the economy but help stabilise inflation. 

The hike in CRR also means that loans are harder to come by. 

The SBI Ecowrap stated on Thursday that the rise in CRR and repo rate 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 too.

However, not everyone is so dejected about the high rates.

Lincoln Bennet Rodrigues, Chairman & founder of real estate developers Bennet and Bernard Company said that the repo rate won’t have a significant impact on home loan rates. “We feel that the rate hike won’t have a significant impact as home loan interest rates have already gone down substantially in the recent past. The overall real estate sector now rests on a strong footing and buying decisions may not be altered by these marginal changes,” he said to BusinessToday.In.

Ramani Sastri, Chairman & MD of Sterling Developers, however, said that the “real estate industry's perennial hope is fixed on lower interest rates as it improves affordability and also provides the required fuel for the growth of the economy along with the real estate sector”. 

Why are interest rates hiked?

Interest rates are hiked, in short, to stabilise inflation that is on high levels now due to the Russia-Ukraine war, throwing off supply chains. High rates will make borrowing costlier which will limit the money supply for the purchase of riskier assets.

High rates discourage consumer and business spending, especially on big-ticket items, such as houses. It reverses the wealth effect and also makes banks more cautious about lending. 

Inflation and interest rates move in the same direction. If inflation is high, interest rates are increased. But economic slowdown lowers the inflation rate and may prompt rate cuts to invigorate growth.

(With Reuters inputs)

Also read: RBI Guv Das announces hike in interest rate by 40 bps to 4.40% in 'off-cycle' MPC meet

Also read: MPC expects inflation to rule at elevated levels: RBI Gov Shaktikanta Das