Contents
When it comes to the issue of high interest rate, it does not matter whether you live in America, a Northern European country or the Middle East. In this context, it should be noted that according to well-known economic theories, no one wants to invest or spend in an environment where interest rates are high. This means a slowdown in the economy, high unemployment, and ultimately everyone gets hurt. In this regard, as we all know, unfortunately, global interest rates have increased due to the high inflation phenomenon that emerged after the Covid-19 pandemic.
At this point, if you have not read our article about the reasons for the increase in interest rate, we recommend that you read it first. As you may remember, after the disruption of supply chains, the start of the Russia-Ukraine war and the sudden increase in energy and wheat prices caused high inflation globally. As part of the fight against inflation, central banks almost all over the world, especially the FED and the ECB, increased interest rates. In this high interest rate environment, instead of taking risks and trading and investing, we the people who are homo economicus generally prefer to earn income risk-free and effortless by investing their savings or money in interest.
It is certain that this situation will stop the wheels and increase unemployment in the medium and long term. Well, isn’t economics the science of managing contradictory goals with maximum benefit and profit? 😊 Nowadays, as we are ending the year 2024, the question on everyone’s mind is when will interest rates go down globally and when we will return to a normal inflation and economic environment.
FED Impact on Rate Cuts
Here we will analyse this issue a little. On the other hand, while examining this issue, we will explain it in a way that readers who have not studied economics can understand. That is, we choose to explain it with current examples without overwhelming you with technical terms. First of all, let us state that the most important move in global interest rate cuts is the FED interest rate cut.
If the FED, which constitutes the majority of the world economy, reduces interest rates, other central banks will probably follow the same path.
The main points we will cover here are:
- When will the FED reduce interest rates? How many rate cuts will happen?
- Base Effect on Inflation.
- Is Foreign Exchange Reserve Status Important?
- Will prices fall when inflation decreases?
- What happens if loan interest rates decrease?
Interest Rates Go Down? Why?
In order to answer this question correctly, we first need to remember why interest rates were increased, friends.
So, if you remember, when the phenomenon of high inflation emerged on a global scale after the pandemic, most countries increased rates as part of the fight against inflation.
It should also be reminded that; In America, the FED gradually increased rate to the range of 5.25 – 5.50. In the same direction, the European Central Bank and other developed country central banks also implemented parallel action policies. In other words, it is a clear fact that in order for interest rates go down, inflation must first decrease. At this point, it is necessary to mention the base effect.
Base Effect, Decline in Inflation
We would like to briefly explain these technical terms to you. Because, when we understand the base effect, it is easier to understand why inflation is falling globally.
By the way, we would like to point out that the decrease in inflation is not a decrease in prices, but a decrease in the rate of increase of prices.
When we understand these, we will have a clearer understanding of when interest rates go down. We would now like to explain both issues to you with examples.
Namely:
– Decline in inflation: Normally, inflation is a continuous increase in the general level of prices, but in order to understand the issue more easily, let’s consider an economy where there is only one product. Let’s say 1 apple was worth 1 USD last year and its price increased to 2 USD this year. The inflation rate in this country that year was 100%. When the price of the same apple increases to 2.5 USD next year, the inflation rate will be 25% (from 20 USD to 25).
So, in this example, inflation has dropped sharply from 100% to 25% in two years. On the other hand, the price of apples was 1 USD two years ago and is now 2.5 USD. During this period, if your salary or income does not increase by the rate of increase in the price of apples within 2 years, your purchasing power will decrease by that rate.
– Base Effect: In the normal world, inflation calculation is not made that simple. It is calculated end-to-end, month-to-month, for 1 year, based on a product and service basket containing many items.
Real Example
In this context, if we start from the apple example, we actually call the base effect the fact that the price of apples increased by 100 percent from last year to this year, and then the price of apples increased by less, that is, 25 percent next year.
In short, we call the base effect when the data or rates calculated by looking at the previous year decrease or increase significantly compared to the previous year. For example, when calculating inflation in October 2024, monthly rates from October 2023 to October 2024 are used.
If monthly inflation was very high in September 2023, inflation will decrease in October 2024 due to the base effect, as this monthly rate will be removed from the new account.
Inflation Falls, Interest Rates Fall
After explaining why interest rate was risen and the related definitions of inflation, it is time to answer the question of when interest rates go down. Those who have been patient and read this far have actually already answered the question. 😊 Yes, for this rates to fall, inflation must first fall. In order to reduce inflation, both monetary and fiscal policies must be implemented simultaneously in a “constriction” manner. Here we need to briefly look at the foreign currency, or in popular parlance for developing countries, the “dollar situation”.
As we all know, the biggest economic indicator in developing country for ordinary citizens is the dollar exchange rate. When interest rate rise, people prefer to keep their savings in domestic money and make deposits instead of buying dollars. In this concept, while thinking about when interest rates go down, we should not forget the dollar exchange rate globally. Here, CDS, risk premium subject (read the article), and the Central Banks’ USD reserves come into play. On the other hand, if USD exchange reserves have increased considerably in a country, it means fear of the dollar skyrocketing with the decrease in the rates has also diminished for that developing country.
In the light of all this information, it should be noted that the month of decline in interest rate, which is indicated by both the base effect, the decline in inflation and foreign exchange reserves, developing countries will probably be soon at the end of 2024 globally.
At this point, the severity of this decrease is as important as the question of when the interest rates go down. In other words, it is important to proceed on the path of rational policies and make gradual moves in this direction.
How Many Cuts?
However, first of all, it is necessary to talk about the interest rate cuts in America in order to accelerate the interest rate cuts in the world globally. Most recently, in June, 2024 the FED kept interest rates constant for the seventh consecutive time. FED also stated that inflation indicators were not as good as he expected in order to start interest cuts. In this regard, in their statement following the Federal Open Market Committee (FOMC) meeting, it was stated that the latest indicators show that economic activity continues to improve.
At this point, it can be said that while three interest rate cuts were previously expected, this number has now decreased to one. In other words, the FED will probably make an interest rate cut in November or December 2024.
After the FED rate cut issue, let’s talk about the scale of the decrease in interest rates. In this context, it should be noted that; In the economy and financial markets, gradual moves and balance are as important as rationality. In addition, there is a risk that the dollar exchange rate will jump if interest rate cuts are made quickly and harshly in developing countries with high sensitivity to the dollar. At this point, interest that will be a few points above inflation, that is, providing real returns, will be welcomed both in terms of investment and loans.
If interest rates go down and still remain above inflation, people will want to keep their money in the local currency and get a real return on deposit, even if it is small. On the other hand, businesses or merchants will use loans as loan interest rate decrease, they will create new jobs, stimulate the economy and contribute to the decrease in unemployment.
