From consumption to innovation, the impact of rising interest rates

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From consumption to innovation, the impact of rising interest rates

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Paris (AFP) – “The Fed raised its rates by half a percentage point.” The ad probably seemed vague and distant to a part of the general public. However, this decision by the US Federal Reserve has consequences for all sectors of the world economy.

The “Fed”, the central bank of the United States, is not the only one to have taken such a measure. The central banks of the United Kingdom, Canada or Poland, to cite a few examples, changed their monetary policy to fight rising inflation.

For the moment, the European Central Bank (ECB) has delayed this decision, despite the fact that it has already begun to withdraw its support for the economy.

This turn marks the end of the era of free or almost free money, after years of very low interest rates that allowed states, companies and households to borrow cheaply.

Central bank beacon instrument

Interest rates are the main instruments of central banks. These are rates applied to deposits or loans from commercial banks.

“Indirectly, they lower or raise the rates that banks are going to charge their clients,” explains Éric Dor, director of economic studies at the IESEG School of Management.

They also have an influence on the rates of the bond market: those of the States, which have an impact on the interest rates of companies, skyrocketed. For example, the rate on the 10-year US Treasury bond doubled in five months and is currently 3%. That of France went from zero to 1.5% in the same period.

Although the ECB has not yet taken the step of an increase, “long-term rates rise in Europe because the markets already anticipate” that it will, continues Dor.

– Raise rates: what for?

“Central banks raise their rates when they want to fight excessive inflation due to very high demand,” says this expert.

Companies are currently increasing their prices to compensate for supply difficulties and the increase in some raw materials.

On their side, households that saved during the covid-19 pandemic can afford to spend more, causing prices to spiral upwards.

It is difficult to predict how long the increase in interest rates will have an effect on consumption, but the purchasing power of households “has already been reduced with inflation and the rise in rates on consumer loans is going to curb their spending “, anticipates Maximilien Monot, portfolio manager of the fund management company Monocle AM.

The situation will also change for real estate loans. Rates have already begun to rise in the United States, driven by strong demand from individuals and builders’ difficulties in completing their projects due to global supply problems.

Investments stopped

If borrowing is no longer free, companies will now have to think twice before doing so. Initially, the impact on the accounts will be felt at the time of refinancing debts contracted at a zero rate.

For new loans, the company must present a project with a higher level of profitability to guarantee its payment capacity. Banks and investors will be more demanding before providing their financial support.

Train cars being manufactured at a company in the Indian city of Chennai on May 20, 2022. Arun SankarAFP

In a mechanical way, “investments and innovation are going to be slowed down by the capacity for indebtedness”, warns Maximilien Monot.

However, there is not too much concern in the short term, since those effects will be felt in companies within a year.

recession risk

Between a fall in consumption -which will lower company sales-, reduced investments, still very high inflation and less accessible loans for States and companies, Éric Dor thinks that “the risk of recession is strong”.

It is the end of the “whatever the cost” of the States, since now helping companies will cost much more, it is an additional brake and could cause the bankruptcy of the “zombie companies” that have lived on perfusion for years.

Financial markets are already showing signs of fears of a wave of corporate defaults.

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