Three rate cuts in 2024: Will you save or spend more money than before?

Dubai: High interest rates made borrowing steadily more expensive since 2020, which in turn naturally discouraged spending worldwide. But with the US and the UAE central banks making their first big rate cuts last night, will you now see your purchasing power grow? In theory, yes! Let’s understand why.

In a surprise move, the world’s largest economy US on Wednesday aggressively cut its interest rates by a larger-than-expected 0.5 per cent, while signalling more similar-sized cuts in the near term. And as history indicates, central banks elsewhere will continue to follow suit.

Economists and veteran investors have widely been evaluating how this would affect people and their finances. These central bank decisions will affect rates at which commercial banks lend to consumers and businesses, bringing down the cost of borrowing on everything from mortgages to credit cards.

How your spending influences interest rates

“Rising interest rates have clearly affected spending on a global level because the cost of borrowing money went up,” explained Mohammad Shaan, a Dubai-based wealth manager. “So, if you have any type of credit card or loan, you ended up paying more for the money you borrowed.

“However, what’s often overlooked is the fact that this will also mean that you inevitably have less money to spend elsewhere. So, while higher interest rates make it more expensive for people to borrow money and encourage people to save, that means people will tend to spend less.”

If people spend less overall, prices tend to rise more slowly, and this is meant to keep inflation in check. But is this what was happening up until now? “Interest rate hikes and restricted spending both helped rein in inflation across most economies, giving them confidence to cut rates,” added Shaan.

Borrowing will get cheaper soon, more so in 2025

As high interest rates meant it’s more expensive to borrow money, big purchases slowed or got delayed. Now with lower rates encouraging borrowing, money supply in the market will increase. For example, the lower the interest rate the lower the monthly mortgage payments on a newly purchased house.

“As interest rates peak now and definitely start dropping henceforth, if you’ve been considering a large financial decision now, such as buying a house or purchasing a car, you can start putting your borrowing plans in motion until you get favourable loan terms between now and the start of 2025,” Shaan added.

“Also, credit cards with variable rates tend to drop when the rates start to slow. So, if you’re trying to catch up on credit card debt, this can be of some help. If you already have a loan, lower interest rates might mean it is a good time to evaluate your current terms and consider refinancing it.”

Make most of interest rates that will keep decreasing

“Your investments stand to benefit when interest rates go down now, but the effect is not seen immediately,” said Brody Dunn, an investment manager at a UAE-based asset advisory. “While your bond investments give good returns in a high-rate environment, stocks will turn profitable now.

“High interest rates made stocks more attractive to investors, as they can generate higher returns than fixed-income investments, leading to a rise in stock prices. Now, investors can get higher returns for those who have invested in stocks and make bigger gains as interest rates drop and markets stabilise.”

Dunn reiterated that as lower rates also incentivise borrowing, businesses make more investments in their business, which drives up their stock prices again. “So, depending on your asset allocation, lower or higher interest rates could affect you positively or negatively,” he added.

Bottom line?

While increasing rates made borrowing more costly and reigned in spending in favour of saving, lower interest rates will now make borrowing cheaper - allowing you to spend and invest more freely. As interest rates start dropping in the coming months, borrowing, and spending will rise.

But what are your next steps? “While borrowing may provide better terms when interest rates are low, it’s still wise to be cautious. In contrast, some areas that could offer lower rates of return when interest rates go down include savings accounts, deposits, bonds, and money market accounts,” added Dunn.

“While your savings account can start to earn more interest when rates rise gradually, it’s important to keep saving regardless of the rates. Especially if you haven’t built up an emergency fund, you’ll want to save in the case of an unexpected major event.”

However, realistically, financial planners often reiterate that for most people, if you have an established savings plan and financial goals, a lower or higher interest rate will most likely not be a significant reason to materially change your saving strategy.