What makes interest rates go up and down?

Interest rates, as we all know, are what determines the cost of our mortgages, loans and sometimes, credit cards. But what makes them go up and down? What is the determining factors that make those grey haired men in corporate government palaces change the amount I pay on my mortgage each month?

I’ll try to help you easily understand why this happens in this post.

The Federal Reserve can manipulate interest rates by buying
and selling bonds in the bond markets. During economic times the Fed wants to
stimulate the market, the Fed buys bonds on the open market, and pays for the
bonds with cash. If the Fed continues buy bonds, the market becomes flooded with
cash. This excess cash in turn makes money more available for people who want to
borrow. The result is interest rates will naturally come down as different
lenders compete for a limited pool of borrowers.

The interest rate to borrow this excess money begins a bidding battle between different lenders each competing for the loan funds (so they can then lend to borrowers like you and me). Just like the most of us, borrowers go for the lowest price.

Interest Rates and A Growing Economy

When the economy is growing, consumers gain confidence, as their confidence
grows people start spending money. What do they buy? Everything under the sun
but consumer goods are the term you will hear most often. People buy items like
cars, computers, appliances like stainless steel refrigerators, etc.

This is the cycle of inflation, which in turn leads to increased interest rates:
1)    As demand for products increase, or more people buy stuff they don’t need, companies can begin to charge more for their products.
2)    When people want more stuff, companies make more money.
3)    As companies begin to make more profits it is not long before workers begin asking for more benefits and more money in their paychecks.
4)    As companies meet worker demands, the company experiences increased cost and expenses
5)    Then inflation begins.

Inflation is the prime cause of interest rate movement. To slow down any inflation, the government (Federal Reserve) starts selling those bonds they were buying before. Considering that the market was awash with cash when they were buying bonds, what do you think happens when they start selling?

That’s right! Money floods OUT of the market, and it makes it harder for lenders to get hold of money, hence the increase in costs to borrow. This then slows down everyone’s mad spending and slows down the economy.

PD

To read more about bonds and how they work, see this post

I was speaking to some friends the other night and they explained that their funds were sitting in the bank because they weren’t sure of what to do with the money. With all the uncertainty going on, it’s hard to see through the marketing hype and tell who is the best value, and who will still be around this time next year.

I thought it would be good to have a series of links to sites that with help you find the best deal. Like i say with all things financial, please make sure that when you decide on a particular company or way to invest, that you learn as much as you can about what you are getting into, and the fees and ‘get out clauses’ that apply. It pays to be knowledged in many areas. Google is a great resource for things like this.

Today, I’ve looked at a variety of different sites that maintain a comparison chart for Interest Savings Accounts and the easiest and most independent is RateCity.com.au

Fixed Interest accounts are a very conservative way to keep your investments above inflation (usually between 2-3%) and can generally be easy to withdraw and contribute to. But they mostly have minimum balances.

The MOST IMPORTANT thing to look at when considering these types of accounts is not just the interest rate, but when they calculate it. Best is if the interest is CALCULATED DAILY and paid at a later date (usually monthly). This way, you will catch any increases on a daily basis instead of possibly missing it if the account is calcaulated weekly or monthly.

I, personally, have found that One Direct have been exactly what I was after. They are easy to use, transfers go through overnight via online banking (as they are part of ANZ) and the interest rate, when I started it, was relatively high. Have a look on RateCity.com.au and see if you can determine it for yourself. Alternatively, if you have had a good or bad experience with an account of this nature, please let me know.

PD

Is it any surprise that the banks claims that they can’t pass on the interest rate cuts, have been shot down by analysts who point to burgeoning margins on margins and corporate loans?

Last week, there was, yet again, another rate cut for Australian mortgage holders, and once again we get the message that banks will not be passing on the full cut due to “increasing cost of obtaining capital”. Verbal diarrhea I hear you say? I’m inclined to agree with you on that one.

It baffles me to think that every time there is a rate hike, the banks put the rate up instantly, but on the reverse side of the coin, nothing happens. It’s a blatant money grab that defies the law of fair trade in this country.

Then we have the Almighty Wayne ‘Super’ Swan coming out against the banks in all his might stating “Certainly I’m pretty disappointed with their decision or the decisions that have been announced so far” on Wednesday. He went on to say that “You know what they’re like, they do need a good kick up the bum occasionally.”

This comes from the treasurer of our country! His opinion is laughed at by bankers, and should not even be printed as it’s not worth the overpriced parliamentary paper it’s written on. What Wayne Swan needs to do is put something in place to demand that banks follow the lead of the reserve bank, as that is what they base their pricing on, otherwise keep his mouth shut. I understand that banks have a responsibility to their shareholders to return a profit, but they also have a responsibility to their customers to give fair business practice, which is clearl not taking place here.

Call me a conspiracy theorist, but do you think a backroom idea is for people to lock in fixed rates in the short term, and then bring in the rate cut to it’s existing customers? Possibly. The fact is that Wayne Swan needs to grow a pair, and do something about the people he is supposed to serve before corporate greed takes over, if it hasn’t already.

If you would like to voice your opinion to Wayne Swan, as I have here, his parliamentary email address is Wayne.Swan.MP@aph.gov.au

PD