Why Debt Is Getting More Expensive: Interest Rate Hikes, Explained

Interest Rate Hikes Federal Reserve

(SPOT.ph) Debt is about to get even more expensive as the Philippine central bank today, November 3, said it would match the U.S. Federal Reserve's interest rate hike. Better think twice before swiping your credit card this holiday shopping season if you're not going to pay your dues in full.

It's rare for the Bangko Sentral ng Pilipinas to announce beforehand that it will raise the benchmark interest rate and by how much—in this case, 75 basis points or three quarters of a percent. It speaks of the urgency of financial authorities worldwide to tame inflation and keep up with the Fed.

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Federal reserve interest rates and central banks, explained

Banks in the Philippines determine interest rates on loans and credit cards based on the benchmark set by the Bangko Sentral ng Pilipinas through its policy-setting body, the Monetary Board. The MB meets every two weeks to determine whether the benchmark, technically called the the overnight reverse repurchase rate, should be kept as is, raised or slashed.

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In this case, BSP Governor Felipe Medalla told reporters he would match the Fed's 75-basis point hike during the November 17 MB meeting. In total the BSP raised the benchmark rate five times this year, amounting to 225 basis points. After November 17, the benchmark will climb to 5% from 4.24%.

Central banks like the BSP and the Fed raise interest rates to cool inflation because when debt is expensive, consumers tend to save instead of spend. When people spend less, there's fewer demand for goods and services and there's pressure for prices to go down.

The BSP's policy rate matters to your money

philippine money
When central banks slash interest rates, it means people are not spending enough.
PHOTO BY Shutterstock
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The BSP's rate hikes guide commercial banks' decisions on their auto, home and personal loans as well as credit cards. If your home or condo mortgage was repriced this year for example, you'll notice that your monthly due went up. That's because the market rate moves in the direction of the policy rate.

Consider a few years back, when the policy rate was at record lows. Your monthly mortgage might have went down for the year. When central banks slash interest rates, it means people are not spending enough. Cheaper debt encourages people to swipe the credit cards or check out their online carts more often. Sales pitches of condo agents can also be more appealing.

Why the BSP keeps up with the Fed

Central banks around the world keep up with the Fed to have a better chance at luring investors, particularly in bonds. High interest rates tend to attract investments or inflows into the bond market because they could earn more.

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Interest rate hikes can also protect the local currency, in this case, the peso, from depreciating further against the U.S. dollar. Remember that one of the reasons why the peso had been hovering close to the P60 vs. $1 level is because the Fed's rate hikes have strengthened the dollar.

There's relief in the horizon, however, as Fed Chairman Jerome Powell signalled that the rate increases could end, meaning borrowing costs would stabilize before they eventually start going down.

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