David T. Nudelman is partner & CEO at Scandinavian Capital Markets, a Swedish STP Brokerage for foreign exchange and CFDs.
Near the start of 2022, the U.S. Federal Reserve (the Fed) and many other central banks around the world had a problem: inflation. Rising costs, caused by the hangovers from the Covid-19 pandemic and the semiconductor crisis, and then exacerbated by international conflicts, were getting out of control. You may remember hearing the word “transitory” as the banks were hoping that this inflation was just temporary. It wasn’t.
The usual way to sort out inflation is to raise interest rates. With a higher cost of borrowing, consumers and corporations are forced to slow down or postpone purchases, thereby tilting the supply-and-demand balance and bringing prices down. The Fed, for example, raised interest rates 11 times and finally stopped in July 2023. The Bank of England started slightly earlier, and the European Central Bank started later, but all followed a similar path.
Going into 2025, we are expecting interest rate cuts from almost all central banks, assuming they are happy with the next inflation figures. Interest rate cuts are always good for most businesses, but we may not be getting the dramatic cuts that we were hoping for. The Fed, for example, will lower interest rates this year, but only by 0.5% based on recent statements.
What happens?
We all know what interest rates are, how they affect our ability to buy a home or a car and how much we have to pay for a loan or a credit card. Once we elevate the discussion from the kitchen table to the boardroom, interest rates can have a major impact on your business, directly and indirectly.
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For example, if your company is looking for a bank loan, the implications are obvious. The higher the interest rate, the more your financing will cost. If that loan is based on a floating rate, you will be constantly monitoring the rates and the impact on your cash flow. However, there is another impact that the average person may not realize. When interest rates increase in an economic region, the value of that region’s currency also increases.
If your business imports goods and services, you will enjoy a stronger currency. If you are an exporter or you rely on international tourists, this may have a detrimental effect on your bottom line. Of course, if interest rates fall, the value of your currency will fall and the opposite results will be realized by importers, exporters and the leisure industry.
Another paradigm, involving the share price of larger corporations, occurs when interest rates fall, thereby decreasing the cost of borrowing. As a result, their share prices increase on the potential of higher profits—and vice versa.
Who sets interest rates anyway?
The setting of interest rates is part of what we call monetary policy and is the job of a central bank. Central banks are found in every economy and are, in theory, independent from the government and make decisions purely based on economic data.
The largest central bank in the world is the one that oversees the world’s largest economy—the U.S. Fed—currently chaired by Jerome Powell. Quarterly, Powell and 18 other Fed officials cast a secret ballot to raise, lower or hold steady on interest rates.
Other major central banks include the Bank of England in London, which oversees the U.K. and the British pound sterling, the Bank of Japan, overseeing the yen, and the European Central Bank in Frankfurt, overseeing the economies of 27 European countries and the euro.
As mentioned above, Powell stated that they may slow down rate cuts in 2025. Immediately, the U.S. dollar shot up and U.S. stock indices fell. This move actually affected many stock indices all over the world, showing just how influential the U.S. markets and the U.S. Fed are.
How do they determine the interest rates?
The biggest single monthly event in the economic calendar is the release of a report called the United States non-farm payrolls (NFPs). This number indicates how many new jobs were added to the U.S. employment rosters. This figure, combined with other elements like a 2% target for inflation, tells the Fed most of what they need to know about the growth of the economy and therefore influences their decision regarding interest rates.
This figure not only affects the U.S. dollar, it affects share prices of U.S. equities and drives every other major currency on the planet. Why? Because the NFPs are a key determiner for the next change in U.S. interest rates and, don’t forget, the U.S. dollar is still the global reserved currency.
Conclusion
As we can see, interest rates don’t just affect the cost of borrowing for your household or for your business; they also shape the attitude of investors, banks, funds and traders, which in turn can dramatically affect the share value of listed companies. The knock-on effect can be serious as companies need to be flexible to make decisions on hiring, expansion, research and development and a variety of other areas.
Moving into 2025, many experts had predicted constant interest rate decreases well into 2026. Unfortunately, the 2% inflation target has proven elusive, causing central banks to rethink their strategy. Geopolitical events and the potentially inflationary policies of the new U.S. administration will skew the data and have central banks constantly repositioning. Watch this space!
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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