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What actually is the key interest rate? And how does it affect me? The answers.
The key interest rate: The key interest rate is an interest rate through which central banks influence the behavior of commercial banks. Because the banks always have to borrow new money, it’s part of their day-to-day business. When banks borrow money from the National Bank, they pay interest. That is the key interest rate. Changes in key interest rates always have a delayed effect. Because it takes a while for the banks to pass on the changed interest rates to customers, to react to the new interest rates for loans and mortgages and for this to have an impact on the economy.
Key interest rate increase against rising prices: If prices rise, the National Bank can increase the key interest rate to slow the price increase. A higher key interest rate means that it is more expensive for banks to borrow money from the National Bank. They pass these higher prices on to their customers, which means it becomes more expensive for them to borrow money from the bank. Interest rates on loans and mortgages are rising. This dampens demand, which means that the population and companies have less money for other things. If we buy less or wait, prices will fall.
Key interest rate hike and the risk of recession: The National Bank’s most important goal is stable prices that rise a maximum of two percent per year. But if the National Bank increases the key interest rate in order to combat rising prices, then there is always the risk of a recession: because less demand means that companies sell less. At the same time, it is becoming more expensive for companies to obtain loans and they are more likely to postpone investments. Both have a negative impact on the economy, that is, they dampen the economy. And if this is dampened too much, it will lead to a recession.
Key interest rate increase and the exchange rate: A higher key interest rate not only affects prices and the economy, but also how much the euro and dollar are worth compared to the franc. This means how expensive it is for companies and the population to buy abroad and, conversely, how expensive it is for foreigners to buy in Switzerland. A higher key interest rate strengthens the franc, at least that’s what economic theory says.
But there are many other factors that affect the exchange rate. A stronger franc means that you can buy more with the Swiss franc abroad. Traveling abroad is becoming cheaper, but conversely it is becoming more expensive for tourists to travel to Switzerland. It is also cheaper for companies to buy abroad. However, a strong franc is bad for companies that export a lot because it makes their products more expensive. In the Quarterly bulletin of the National Bank on the “Reaction of the Swiss Franc to interest rate changes by the National Bank” you can find further information.
The three mechanisms all work – at least in theory – in the opposite direction. The National Bank must therefore weigh up which policy change is beneficial or drastic for whom.