Decoder: Why you should be interested in interest rates now

Inflation is one of the biggest worries for Gen Z and Millennials. Here’s why you need to care about rising interest rates — and what you can do.

For the first time in more than a decade, interest rates across the world are rising from what some say were their lowest levels in 5,000 years.

You heard that right. The idea of lending money — and charging a fee for doing so — is as old as civilisation. Central banks, the institutions now responsible for guiding a country’s rates, are much more recent. Sweden’s Riksbank, in 1668, was the first, closely followed by the Bank of England in 1694.

Don’t worry. This spin through history is meant only to show that interest rates have a long, if not always respected, past.

In our drama-filled present, the world is watching — with interest — where they will go from here.

So why do interest rates matter? And why now, in particular?

Why do interest rates matter?

To vastly oversimplify the argument: lending rates matter because prices matter. And interest rates are the most tried-and-tested tool for keeping prices under control.

Even those who prefer getting their financial advice from TikTok and YouTube, rather than consulting traditional financial institutions, would be hard-pressed to miss the fact that prices for essentials such as food, fuel and cooking oil are rising faster across the industrialized world than they have in decades.

This can be particularly hard for those starting their working lives. Nearly half the Generation Zs and Millennials in a 46-country Deloitte poll said they live paycheque to paycheque. Of the thousands surveyed, nearly one-third (29% of Gen Zs and 36% of Millennials) said inflation was their most pressing worry right now.

The global rise in prices is the result of a perfect storm of factors: among others, a food shortage caused by Russia’s blockade of Ukraine’s ports, soaring energy costs and the effects of droughts, heatwaves and other climate-linked extreme weather on agriculture; a resurgence in consumer buying deferred during COVID-19 lockdowns; and a surge in demand for workers.

And while wages are also rising after years of near dormancy, they are not increasing fast enough to keep pace with prices. So even the most carefully managed household budget is facing new strains.

That’s where interest rates come in.

Slowing inflation without stalling economies

Central banks hope that by making it more expensive to borrow, they can slow the pace of inflation. That they have been able to keep rates at or near zero for so long is because the world was in an extraordinary period of extended price stability.

There is little that even the cleverest economic steward can do to fix the external factors affecting inflation — Ukraine, droughts, labour shortages — but they can try to put the brakes on internal drivers such as consumer demand.

So that’s why rates are increasing in most major economies faster than they have since the latter part of the last century.

The U.S. Federal Reserve, arguably the world’s most powerful central bank, has raised rates three times this year and is expected to increase them again this week. Peers such as the European Central Bank and the Bank of England are following suit, although some are taking a cautious approach because they want to slow their economies without stalling them completely.

The question is: How far will rates rise and how will that affect a global economy that has been buffeted in the past few years by a pandemic, geopolitical turmoil and a supply chain crisis?

Consider hypothetical futures.

Economists say a few possible paths lie before us.

The best-case scenario is what they call a “soft landing”: interest-rate rises could put a quick end to the price spiral without causing a halt or, worse, a reversal in economic growth. When prices stop rising, rates do too.

There are potential pluses for the young in this brightest of hypothetical futures. It could allow wages to catch up with costs, boosting buying power. And if there is a halt or reversal in property prices, they could at last have a chance to buy without having to face cripplingly high mortgage rates.

The second-best scenario is a brief recession that ends quickly and brings with it tamer prices and stable or lower lending rates. See above for benefits.

“I am not confident in the soft-landing scenario,” said Greg McBride, Chief Financial Analyst at Bankrate.com. “A recession is very likely the price to be paid for getting inflation under control. And painful as recessions are — even mild recessions are not fun for anybody — that is medicine we are better off taking now in an effort to get back to price stability.”

If interest rates rise too slowly or not enough, this opens the door to the worst of all possible worlds — a phenomenon known as stagflation.

Stagflation is an ugly thing. Prices soar, economic growth slows and it becomes harder and harder to make ends meet. The fact is that economic growth will slow as rates rise, even in the best of our possible outcomes. But as long as prices follow, we will escape the economic purgatory that big economies faced in the 1970s.

Now is the time for smart financial management.

Whatever future lies ahead, McBride said, the best way to ride it out is to practice sound financial management. That applies whether you are a student, just joining the job market or starting your own business.

“The fundamentals are critically important,” he said. “That is: invest in yourself and your future earning power; watch your expenses; live beneath your means; save and invest the difference; and don’t rely on debt to support your lifestyle if your income cannot.”

This last is particularly important in a time of rising rates.

“There are points in life where you need debt,” he said. “You may need to borrow to get through school. You’re probably going to have to borrow to buy a house.”

But you must never lose sight of “the end game” of paying that debt off, particularly if, as with most credit cards, it carries high or variable interest rates. And don’t borrow for non-essentials.

McBride said: “Leaning against debt, like a crutch to support a lifestyle your income cannot, doesn’t lead anywhere good.”

Questions to consider:

1. How have the prices for food, fuel and other goods changed where you live?
2. What is stagflation and why is it the worst-case scenario?
3. How can policymakers tame inflation?

Sarah Edmonds has been a journalist for three decades. She spent 27 years with Reuters in seven countries on three continents as a reporter, news editor, bureau chief and news operations manager.