How do I prepare for higher interest rates? And more importantly, do I need to prepare for higher rates? In general terms, it is very difficult to predict in what direction interest rates might go. That is because rates of interest are often predicated upon human behavior. However, currently interest rates are at historical lows. When an interest rate is at or near zero interest rate prediction becomes much easier. Interest rates are going to go up because that is the only direction they can move.
It is safe to say that interest rates are going to be moving higher over the balance of 2010. When they start to move and the magnitude of the move is harder to gauge. The central bank of Australia has already begun to inch rates higher. The Bank of Canada, which currently has prime set at .25%, anticipates not moving rates until the end of June 2010. It is thought that the American Fed might hold the line in raising rates until the 3rd or 4th quarter of 2010.
The direction in which the rates will move is dependent upon three separate but primary factors. Interest rates are affected by the supply and demand of available cash. They are also affected by the monetary policies adopted by the central banks of each country. Lastly, the rates of interest are affected by inflation rates. Interest rates tend to act in global synchronization, although the pace of moves and magnitude of moves can vary widely between countries.
The supply and demand of available money affects interest rates directly. The general rules of supply and demand apply in the financial industry just as they apply in every other industry. If the banking industry has access to a lot of money and the demand for this money (people who want mortgages or loans) is low then supply exceeds demand and interest rates stay lower. If the number of people seeking loans (demand) exceeds the amount of available cash (supply) you will begin to see rates raise. With the credit crunch of the last 18 months supply has been limited but so has demand. Just remember when money is plentiful then money is cheap.
Monetary policy is set by individual governments in an attempt to regulate their economies. In broad terms central banks regulate the rate at which they print money. A loosening of monetary policy sees the central banks printing more money. A tightening of monetary policy sees the central banks reducing the amount of money they print. Central banks tighten and loosen their monetary policies in an effort to constrain inflation and sometimes to affect the value of their currency on the foreign exchange markets. the central banks are trying to kick start the market so they want people to have access to money.
Inflation is the last major factor to affect the rates of interest. In an inflationary environment, lenders demand a higher rate of return on their investments or loans. In a period of low inflation, lenders are prepared to accept much lower rates of interest. The percentage by which the loan exceeds the rate of inflation reflects the margin of net profit. Just remember low inflation = low rates and high inflation = higher rates. We are currently in a period of relatively low inflation.
The current rates of interest are bound to go up even though the three primary factors effecting rates suggest lower rates. However, when the only possibility for movement is in one direction it is a pretty safe bet that rates will move in that direction. The exact moment rates will begin to rise and the rate of increase is unknown. The best guess right now is that rates will go up moderately in late 2010. You should start to think about how to prepare for higher interest rates.