Interest rates Interest rate forecast: be aware of these factors

How are interest rates changing? We look at how you might tell where they are headed.

by UBS Insights 08 Jun 2021

The saying “one person’s trash is another’s treasure” is especially applicable to interest rates. While low rates are bad news for savers, they are great news for mortgage holders. Indeed, the last 40 years have been good for the latter. Interest rates have been gradually falling and remain low at present. But for how long?

This depends on the overall global economic climate – a highly complex topic. We address the most important factors that property owners should bear in mind. We also explain why it is a good idea to consult in-depth analyses from financial institutions, even if you have basic knowledge of these factors.

The base rate – the decisive factor

The base rate is determined by the Swiss National Bank (SNB). This rate sets the direction for all financial institutions that use interest rates, although mortgage rates also depend on other separate factors.

The interest rate policy of the SNB pursues two clear objectives, which are written into the Swiss Constitution: firstly, the SNB must ensure stable prices. Secondly, it should take account of the economic situation.

Just what exactly is an interest rate? Simply put, it is the price for the money you borrow. If the SNB sets low base rates, then borrowing money is cheap. This is because cheap money can flow into the economy, which tends to have a stimulating effect. If the SNB raises interest rates, then money becomes more expensive, potentially slowing down the economy.

Inflation – a warning sign

In order to set the base rate, the Swiss National Bank monitors inflation. To this end, the Federal Statistical Office regularly publishes inflation rates. These reflect the prices of various goods and services in a consumer’s basket, for example, food, clothes, rent, transport, leisure and much more.

The word “inflation” comes from the Latin inflare, meaning “to blow up” or “swell.” Inflation thus refers to an inflated supply of money, and can lead to rising prices and a loss of purchasing power. If the SNB fears a dramatic rise in the inflation rate, it will raise interest rates. This makes it more attractive to save money than to spend it, thus helping to stop inflation.

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Keep an eye on the economy

A booming economy leads to a growing demand for capital. Theoretically this raises the price of capital, i.e., interest rates. This is why those seeking to make interest rate forecasts need to understand the current state of the economy.

One highly respected early indicator is the “Purchasing Managers’ Index” (PMI). It indicates whether purchasing managers in industry are optimistic or not about the future. Owing to the USA’s position as a leading global economy, the American PMI receives a particularly great deal of attention. As a rule of thumb for interest rate forecasts, if the US economy is neither spluttering nor running at full speed, central banks will keep interest rates low.

What are others saying?

One thing that market participants don’t like are surprises. Indeed, any change to interest rates has the potential to torpedo a financing or investment strategy. As a result, central banks usually try to fulfill the expectations of market participants. They communicate their intentions well in advance and avoid making sudden U-turns. Falling interest rates are usually welcome in business circles, whereas rate hikes make money more expensive and discourage investment.

Central bank policy – the USA as bellwether

The Swiss National Bank monitors the activities of other central banks, especially those in America and Europe, and usually follows their lead. If major economic zones pursue a policy of “cheap” money with low interest rates, Switzerland will not want to go it alone by increasing its interest rates. This would raise the price of the Swiss franc, already popular as a haven among international investors. It would also make life difficult for Swiss exporters, whose products would become more expensive.

Interest rate curves – a simple tool to use

Different interest rates apply depending on the term of a loan. It is commonly assumed that the longer the period during which someone borrows money, the higher the interest rate will be. This is because a longer maturity increases the credit risk. Aligning interest rates based on their maturity creates a yield curve. This typically points upwards, meaning that short-term interest rates are lower than long-term rates.

What is interesting is that yield curves reveal a lot about interest rate developments. If the curve is steep, this means that market participants expect interest rates to rise. A flat curve indicates a sideways trend. What about if long-term interest rates are below short-term rates? This is known as an inverse interest rate structure and indicates that interest rates will fall.

Seeing the bigger picture

Ultimately, having an overall picture is crucial to a meaningful interest rate forecast. Using detailed analyses and models, research teams at banks examine huge volumes of market data to arrive at meaningful conclusions. It is therefore worth being aware of and monitoring the individual factors, and keeping up to date with the findings of banks and other financial players.

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