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Interest rates

I think that, when you saw the title, most of you probably thought: ‘Not more about interest rates, how tiresome’. There has been talk of inflation and interest rates for so many months now, I think we are all fed up of it. We often do not really know what all this means for our day-to-day lives, however, and we need to have that clear in order to make the best decisions.

Central banks have been raising interest rates for more than a year. That basically means that money is more expensive. This means that anyone who needs to borrow money, in addition to returning what they have been lent, will also have to give a return to the lender and, with high rates, the return they will ask for will be higher. Faced with this situation, we can be on one side, on the other or even on both sides. Let’s say we need money to buy a flat and we ask the bank for a mortgage. The bank will ask for higher interest because the Euribor, the reference for almost all mortgages, is at its highest level in the last fifteen years. On the other hand, however, if we have some savings, we will be able to make better use of them because we will be the ones lending this money to a state or a company through financial products and they will pay us much more than a year ago.

How long is this going to last? Why do central banks raise rates if this only benefits people who have money? The answer is easier than it is pleasant. Central banks aim to reduce inflation and this is the way to do it, because it cools the economy. If we stick with the example above, someone who is thinking of buying a flat might postpone the decision to buy precisely because the rates are high. Reduced demand for flats, under normal circumstances, would lower prices and, consequently, curb inflation. On the other hand, those who have some savings may now prefer to leave them invested and generate extra returns instead of buying products they like but may not need, leaving purchasing decisions for later. Again, the reduction in demand for goods and services would help to reduce inflation. The fact that the central banks have skyrocketed the price of money therefore responds to the desire to reduce people’s consumption. In the same way, when it is necessary to stimulate the economy, they lower the rates so that we can all consume.

You may recall that, a few months ago, I wrote about what inflation means and what impact it has on our pockets. In the end, the conclusion I drew was that we not only need to save, but also to invest. At the point we are at, I think it is essential to bear in mind everything I have explained, because we can find ourselves in a third scenario, as I told you before: being on both sides of the equation. Many of us can find ourselves in the situation of paying off a mortgage and also having some savings. While it may often cross our minds to get rid of the debt burden, it may not be the most efficient thing to do. Is it really worth running out of savings or is it better to have the money invested and have the returns compensate us for areas where we have to pay more? If we keep some savings invested, we can continue to direct them towards the most suitable type of asset with high or low rates. On the contrary, if we get rid of savings, we solve a short-term problem and are left with no room for manoeuvre when faced with a change of scenario.

We do not know how long this situation will last because it depends on the evolution of the economic situation, inflation and the central banks. I do think, however, that it is an important enough issue that we should not only be aware of the headlines, but really understand what it means. That way, we can ensure our future financial planning is sound.

Diari d’Andorra 11.10.2023

CreandExperts
CreandValor
Written by
Autor post
Robert Sanz
Equity and Flexible Accounts Portfolio Manager at Creand Crèdit Andorrà