Most countries have recently slashed their interest rates due to the slowdown in inflation and stagnant economic growth as a result of the emerging economic crises between many countries such as the United States and China which in turn has affected the global economic growth rate. This has prompted the US and Russia to slash their interest rates.
An interest rate is the rate that each country’s central bank pays to commercial banks for deposits, whether it is a one-day, one-month or several-month investment. The interest rates set by the central banks are an indication of the interest rates of commercial banks that should not be lower than their rates. The central bank also uses the interest rate to control the money supply in circulation by changing it in the medium term.
Raising interest means reducing borrowing and thus reducing liquidity in the market, leading to lower inflation.
Lower interest rates mean higher lending capacity and higher inflation.
Factors affecting the interest rates
Interest rates are determined by the forces of supply and demand. If demand for the money supply falls, this will lead to lower interest rates while raising lending rates in economic circles.
Increasing or decreasing interest rates can have a direct effect on various financial markets. As a result of the movement of funds within the financial markets, these markets are interconnected. Interest rates are responsive to the forces of supply and demand. Low-interest markets expel capital leading to a decrease in the supply of money in these markets but banks with strong solvency can withstand this especially if it has great liquidity.
Interest rates also rise when the economy is booming. Interest rates tend to increase in periods when economic institutions need to increase production and therefore need financing to cope with the state of economic recovery.
Principal Interest Rate: This is the minimum interest rate at which a central bank lends to commercial banks for a week. It is also the maximum interest rate provided by the Central Bank against deposits from commercial banks.
Russia’s interest rate cut
Over the past year, Russia has cut interest rates three times already. On June 14, Russia’s central bank has slashed their rates for the first time since March 2018 to 7.5% due to the slowing annual inflation.
On July 26, the Russian central bank cut its key interest rate to 7.25%, down by 0.25% and promised that a third rate cut would be assessed in September.
On September 6, the Russian Central Bank announced in an official statement on its website that the interest rate was reduced by 0.25% to reach 7% per annum, bringing the interest rate in Russia back to the same level as in March 2014.
A few days before the announcement of the annexation of Crimea to the Russian Federation, the Russian central bank raised their rate to 7% from 5.5%, due to significant changes in the financial markets and the,n the Russian central bank raised the interest rate again in April 2014.
The decision to increase the interest rate as much as 6.5% was done in order to reach 10.5 to 17% and it was agreed upon by the Central Board of Directors meeting in December 2014.
The central bank changed it economic growth forecast this year by cutting to a range of 0.8-1.3% which in its previous estimate was 1.0-1.5%.
The rate cut is due to stagnant economic growth and slowing inflation which caused the Central Bank of Russia to reduce its GDP forecast as inflation in August was lower than previous expectations and is expected to reach zero this September.
The decision to cut the third interest rate for this year did not contradict expectations as all experts and economic analysts agreed that the low inflation rate will push the Russian central bank to reduce the interest rate on an official level. Inflation is expected to be at a low pace for this year and next two years and therefore, the Russian central bank has a good reason to cut interest rates.
The Ministry of Economic Development predicted that inflation will reach zero during the month of September as the ministry pointed out in its previous report that inflation slowed during the previous month to reach 4.31% annually.
The ministry said that the inflation rate in August came in below expectations, noting that in its previous report had suggested a deflation during the month of August estimated between 0% to 0.2% on a monthly basis. The slowdown in inflation was due to the seasonal decline in the prices of vegetables and fruits. For 2019 as a whole, inflation is projected at 3.6% to 3.8%, owing to the lack of consumer lending and the weak dynamic of corporate and mortgage loans.
Russia’s interest rate cuts and the global economy
Due to the increased risk of a slowdown in the global economy, Russian economist and head of the Central Bank of Russia, Elvira Napolina said in an announcement that the bank will consider a key rate cut in the coming period.
She added that a decision on the subject will be made taking into account the actual dynamics and expectations of the target level of inflation, economic development, as well as the identification of risks by external and internal conditions, and reactions the financial markets are on the verge of a future cut.
However, she declined to respond on whether the central bank is ready to cut rates at its next meeting in October, or the next in December and explained that the main rate cut is possible at any of the next three meetings.
US interest rate cut
The Federal Reserve, after several weeks of expectations on the direction of US monetary policy makers on interest rates, unanimously decided to cut rates by 0.25 percentage points.
The official and informal economic circles were more preoccupied with the decision than before, as everyone began to look into the reasons for this decision and whether it was in the interest of the United States or not, especially with the knowledge that the US economy is really strong.
There was also a storm of other questions related to the reasons for this decision: What is the impact of the decision on consumers and the prices of goods and on other currencies because of the very strong link to the US dollar? Also, what are the reactions of banks which are considered to be the most affected by this decision?
Why slash the interest rates?
Some economists argue that one reason US President Donald Trump is concerned is his belief that low interest rates will help him win the ongoing trade war against China.
Some analysts believe that the main reason for the possible rate cut is US President Donald Trump’s desire for the dollar to be stronger.
With low interest rates, economic theories show that money will move out of the US to find places that offer better interest rates, necessitating capital inflows. This theoretically makes the value of the US currency lower which makes US exports less expensive and imports more expensive.
Another reason for President Donald Trump’s approval of low interest rates is expected to be the fight against the expected economic damage caused by the trade war against China as US manufacturers are expected to be affected by higher steel tariffs while state farmers will suffer.
There may be a slowdown in the economy or a consequent recession, in which US President Donald Trump will be the guilty party, contrary to what has been the case.
After a 2.1% rise in GDP in the second half of this year which is a much higher-than-expected economic growth rate, analysts see difficulty in understanding the economic reason for the decision to cut interest rates only seven months after the last decision to raise it.
The recent rate cut had no real economic reasons; it was merely a political decision designed to win Trump’s approval. The general economic indicators in the US now look great and the measures for measuring domestic consumption are going well. In terms of employment, unemployment rates in the US have been at their lowest level in more than half a century.
Strength of the US dollar
Raising interest rates makes investments in US treasury bonds and other assets more stable and secure than any other investment and this results in large amounts of money being invested outside the United States, especially from non-emerging markets where investment risks are high.
These factors lead to gains for the US dollar against other currencies which significantly affects the trade and political environment.
For example, the euro fell to the level of 1.0428 dollars, or 1.9%, and the value of the two currencies is expected to reach parity in the near future and if the interest rates will happen the other way around, it weakens the dollar and it is actually what is happening.
What people from outside the United States are interested in is the effect on the interest rate. Because the dollar is a major measurement currency and because many goods and services are valued and many currencies are tied to it, the impact of the US interest rate may be felt in the region as well.
Gold, oil and other dollar-denominated commodities are falling in dollar terms, competitiveness of exports and import costs increase, leading to trade imbalances. Currency markets have become volatile in the past months due to the decision to cut interest rates.
Are the stock markets affected?
Equities are not directly affected but raising interest rates means reducing the amount of money supply and thus getting anything more difficult.
Another substantial effect of interest rate cuts on the stock market is related to the stock price. Many investors use a specific method for valuing companies by calculating the company’s estimated liquidity in the future and subtracting from the current liquidity, and then splitting this number on the number of shares available in the company. The result is very much in making many investor decisions.
If it appears that a company is cutting its growth-spending or making less profit because of its large debt and interest, or because of a lack of revenue coming from investors, it will result in a decline in the company’s stock prices and this will affect the market prices whole.
Confusion has spread in the US financial community after the decision to cut interest rates on the future policy of the US central bank. Analysts disagree, with some expecting the Fed will not take a decision to cut interest rates again at least this year while others expect another decision by the Reserve.
The Fed’s credibility is at stake and this has added to the confusion on Wall Street where the rule of political independence that the Fed has always claimed to have becomes highly questionable.
The Fed needed to convince economists by making a lot of effort that it made the decision for the economic reason of maintaining economic growth in the US rather than simply submitting to the pressures of Donald Trump, who has been demanding a rate cut since he took office.
The White House and the Federal Reserve including its president, Jerome Powell, have long been at odds because this demand has not been met.
Russia and the United States have cut interest rates in pursuit of economic growth and inflation in line with their future strategy which also affects the international economy and financial markets.
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