How Inflation Affects Interest Rates

Inflation is a key factor in things that affect interest rates. When a surge in inflation occurs, a corresponding increase in interest rates takes place.

Over time prices of things tend to steadily increase. Therefore your pound today will be worth more than your pound tomorrow. For example, you could buy a couple of sweets when you were younger for a pound. Today, you get very few for a pound. That is inflation.

Lenders are very aware that inflation will erode the value of their money over the time period of a loan, so they increase interest rates to compensate for the loss. This is how lenders are able to stay visible over time with multiple borrowers and multiple outstanding loans. Adjustments are made to interest to recoup the loss made when money loses value.

The basic premise is this: Low interest rates put more buying power in the hands of consumers. When more money is spent in the economy, prices go up, naturally creating inflation. If there is then a chance that the economy can grow too fast (demand outpaces supply) interest rates are increased, which slows the amount of money entering the economy.

Remortgage loans have repayment based on interest rates. Interest rates are basically the cost of the money borrowed, it is how a bank or lender makes money by letting you borrow money. If you have a loan that has an interest rate that fluctuates then your payment will increase or decrease according to the change in interest rates. Interest rates in turn increase or decrease according to the activity of the inflation rate.

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