The global economic turnaround seems to be complete as more developed countries continue to hike interest rates in anticipation of a continuation in economic growth. The U.S. was first among the top economies in the world to switch to tightening in December 2015. Now, the U.K. has joined in after the Bank of England hiked its base lending rate last year.
Rising interest rates are music to the ears of investors, but not so much to the average consumer that has a heavy burden of credit payments. Stock markets typically rally during periods of rising interest rates, which has been the case for the U.S. markets over the last couple of years. On the other hand, lending rates go up as well, which is unwelcome news for borrowers.
The top three Indices, including the Dow Jones Industrial Average, the S&P 500 Index and its ETF, the SPDR S&P 500 ETF (SPY, Financial), and the NASDAQ Composite have all hit historical highs multiple times over the past several years, and they do not appear to be slowing down.
The U.K.’s rate hike late last year followed 2016’s interest rate cut, which saw the Bank of England reduce it from 0.50% to 0.25%. The latest hike of 25 basis points takes it back to 0.50%. Meanwhile, the U.S. funds rate was increased by an additional 25 basis points in December. It now stands at 1.5%.
Reports also indicate that while the Federal Reserve has yet to agree on the frequency of rate hikes going forward, there could be as many as three more this year, taking the funds rate to 2.25% if the 25 basis points increase is maintained. This will certainly increase optimism in the stock market as investors look to capitalize on the returns resulting from high interest rates.
For borrowers, however, the consequences of these rate hikes might not be received with the same optimism, especially for those with lines of credit on floating rates. An increase in the Federal Reserve Funds rate means lending rates will go up. As such, various lines of credit, such as credit cards, car loans and student loans, may be affected in the long run.
So what can consumers do to limit their exposure to increased credit payments? Well, the best thing to do is to assess refinancing options that will keep rates more predictable and stable. While some loans may have to remain on floating rates, borrowers can switch other credit lines to fixed rates.
This will ensure that if interest rates are hiked again this year, then the interest rates on loans directly affected remain fixed. And while mortgage rates are not directly linked to the Federal Reserve Funds rate, they could be affected in the long run. In the U.S., floating rate mortgages usually have a starting period where the rate remains fixed.
Mortgage refinancing is slowly becoming a popular practice in the U.S., but it is not as common as in markets like Australia and the U.K. For instance, following the U.K.’s most recent rate hike, analysts predicted there will be more rate hikes in the country in the coming months. This has already rattled the mortgage market in the U.K., with borrowers moving quickly to remortgage their loans with fixed-rate lines of credit. According to one of the country’s top firms that provides solutions for remortgages with bad credit, the number of remortgage applications has skyrocketed over the last several months with consumers convinced the rates will continue to rise this year and in the coming years. While triggering a mortgage refinancing option attracts a high initial cost, the savings down the line are deemed to be good enough to compensate for the initial expenses.
Conclusion
In summary, interest rate hikes paint a good picture of a country's economy. A steady increase in the rate is a demonstration by the central bank that the economic growth is realistic and is expected to remain strong for the foreseeable future. Financially, this increases the appeal of fixed-income investments and, in a way, the stock market.
Borrowers tend to find it a lot more challenging as their interest payments are negatively affected, however, especially short-term lines of credit on floating rates. But as we have seen, even auto loans, student loans and mortgage rates might be affected in the long term. As such, credit reorganization might be a smart thing to do as consumers await more rate hikes.
