HOW ARE YOU AFFECTED BY IT?
One of the monetary tools to tame inflation is to raise interest rates. This is textbook economics.
BSP raised it to 4.25% [from 3.75%] on the 23rd of September 2022 to control the rising inflation which is now at 6.3% (from 6.4% in August 2022).
How does the 4.25% interest rate impact you?
1) Banks will raise interest rates and will affect the financial systems.
How?
Reserves earn more. Banks will prefer to remain their reserves with the BSP.
What are reserves?
BSP is a bank of banks [BPI, BDO, Union Bank, etc.] These banks keep 12% of their reserve requirement ratio [RRR] from deposits at BSP.
For every Php 1.00-peso deposit you put at your bank, 12 centavos are kept at Bangko Sentral as reserves and the 88 centavos are lent out.
Reserves cannot be lent out to businesses but can be lent out to banks to earn interest.
RRR is the tool of BSP to control the money supply.
If BSP increases the supply of money faster than the growth of the economy, it’ll result in increasing inflation.
2) Businesses and consumers will cut back on borrowing.
3) Consumers will be motivated to keep their money in the bank.
But remember this, keeping your excess funds for long-term goals [e.g. retirement] in the bank is not a good option as inflation will not fully maximise the potential of your money.
4) If you have a variable interest rate on your mortgage, the high-interest rate will eat up a bigger portion of your disposable income leaving you with little cash for spending.
However, if your interest rates are fixed, your mortgage payment remains unchanged with the rising interest rates.
5) If you are an investor in the stock market, higher interest rates will affect the earnings of the companies as it’s expensive to raise capital so it’ll affect future growth prospects.
If you invested in bonds, [lenders or investors in debt] an increase in interest will result in lower bond prices.
6) Businesses will pull back their investment projects and cut back on borrowing because consumers are not buying. In effect, it’ll slow down economic activity.
As a result, fewer jobs or the available jobs offer lower salaries and wages resulting in lower income for households.
This is textbook economics - increasing interest rates should lead to lower spending and borrowing resulting in lower inflation.
