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Higher interest rates and rising level of inflation are generally viewed as bad both for the stocks and the bonds market; and good for the commodities market. Yet there would be some exceptions due to complex Inter-market relations. More importantly, expectations play a very prominent role in the determination of interest as well as inflation rates.
Following are key determinants of interest rates:
1. Expectations: Interest rates are built around future expectations. If people have credibility in the functioning of the central bank, they will take actions which keep the interest rates steady.
2. Inflation: Inflation is good for borrowers and bad for lenders. When lenders expect inflation, they will charge higher interest rates.
3. Foreign interest rates: These rates have influence on the domestic rates. For example, if the Canadian dollar is under persistent pressure due to lower rates, in comparison to USD, the Bank of Canada may act to strengthen the Canadian Currency by raising the Bank rate.
4. The central bank can regulate short and long term rates. Pumping money into the economy will trim rates, while tightening the supply will prop up rates. In any case, the bank will not be able to influence the long term rates.
5. Interest rates and risk valuation go hand in gloves. There is always a risk premium on all kinds of rates prevailing in the economy. Lenders will demand greater return in risky situations. An investor will ask for a greater risk premium over a risk free rate when investing, for example, in high risk debentures.
6. The supply and demand of loanable funds play a great role in interest rate determination. For example, government deficit may lead to higher borrowing and consequently an upward pressure on rates. In contrast, easing of money will lower the rates. Similarly, an increase in the savings of government, companies or households may reduce demand and interest rates.
DISCLAIMER: The views expressed in this Blog are my personal views/analysis. It does not represent views of any organization or group, for which I am doing consulting or employment. The purpose of this blog is academic and informative; and is not sale of any product or service. The author does not own responsibility (liability) for any information presented in this blog; as investment information tends to change rapidly.
