The ups and downs of interest rates: How rate moves may affect your financial goal

If you have been paying attention to daily financial news, you may not be surprised to hear the news of interest rate hikes or interest rate cuts by the Federal Reserve from time to time. Under Hong Kong's Linked Exchange Rate System, Hong Kong interest rates should theoretically follow changes in the US. Whenever the Federal Reserve announces an interest rate move, the question that follows is, will Hong Kong follow?

What is interest rate? Will interest rate changes affect your financial plan? What is the "Negative interest rate" that often appears in the news recently?

Get to know the Federal Reserve

The Federal Reserve, or Fed, conducts the United States monetary policy and regulates its banking institutions. One of the Fed’s main jobs is making sure the U.S. economy stays on track. They do that by adjusting interest rates—or rather, one specific interest rate called the federal funds rate. That’s the rate that banks charge each other to borrow money for short amounts of time, usually overnight.

The federal funds rate doesn’t directly affect most people, but you still feel its pull because it influences another rate called the prime rate. When the Fed changes the federal funds rate, the prime rate typically moves in the same direction. And the prime rate is a reference for everything from bank deposits and loans to credit cards and adjustable-rate mortgages.

Understand the different interest rates in Hong Kong

The interest rate market in Hong Kong is diversified. In addition to the Base Rate, there are the Prime Rate and the Hong Kong Interbank Offered Rate (HIBOR). The Prime Rate in Hong Kong is the basic loan interest rate that banks give to customers with the best credit quality. The fluctuation is usually small and relatively stable compared to the interest rate. The HIBOR is the mainstream of mortgage products, and the unsecured loans of SMEs are also calculated based on the 3-month HIBOR. Whether raising or reducing interest rates will have an impact on your personal finances. Changes in interest rates will affect your loan interest rates, such as: mortgages, credit cards debt, etc.; and the interest obtained from your deposit account or investment portfolio.

Are changing rates good or bad?

Interest rates are more like an indication of the overall economy. When the economy is in good shape, raising interest rates can prevent the economy from growing too fast and causing high inflation. On the contrary, lowering interest rates will help the economy continue to grow. Once you understand this, there is no need to worry too much about changes in interest rates, but more attention should be focused on achieving your long-term financial goals.

Effects of Negative Interest Rates

Under the impact of the Coronavirus pandemic (COVID-19), the global economy has suffered a severe setback, and some industries are almost shut down. In the future, there may be more central banks in major economies that will join in the implementation of negative interest rates and other unconventional currency measures to "save the economy."

The "Negative Interest Rate" policy is that the central bank sets the nominal interest rate below zero. The central bank will charge interest on deposits or excess reserves placed by commercial banks in the central bank. The purpose is to allow commercial banks to withdraw funds deposited in the central bank, thereby encourage banks to lend abroad, increase investment by enterprises and increase consumption by the public, thereby stimulating economic growth.

However, so far, economists have failed to reach a consensus that Negative Interest Rate policies can bring positive effects to the economy. Referring to the European Central Bank's experience, the Negative Interest Rate policy was implemented as early as June 2014. At first, it may be conducive to credit growth. However, after a few years, the eurozone economy was still weak and closed to stagnation in the fourth quarter of 2019. Before the interest rate failed to rise, the economic crisis reappeared, and interest rate cuts were limited again. The European Central Bank had to continuously expand its balance sheet to stimulate the economy, causing its balance sheet to GDP ratio to soar rapidly and significantly higher than other major markets.

Investment involves risks. This information is for general reference only.

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