Interest Rate Forecast

Interest rate forecast is a measure used to determine the estimated interest rates for future years. It can be a short-term forecast for a few quarters or a long term interest rate forecast for the next 10 years. In most countries, economists and policymakers are the ones primarily involved with the forecast of interest rates. However, even banks are a part of this forecast mechanism. For example, the Federal Reserve is responsible for releasing the forecast for a quarter. However, the accuracy rate of this forecast is not always correct and has a considerable chance of moving opposite. 

The concept of interest rates has stayed active since 3000 BC. At that time, rates were as high as 20%. However, it is tough to see the same in today's world. Due to various factors like savings rates, the importance of this forecast has arisen among borrowers and lenders in the past few centuries.  

Through the implementation of forecast methods, it is feasible to predict interest rates. However, this forecast depends on certain factors like economic growth, inflation, monetary policy, government debt, savings rate, and other macroeconomic factors. The level of growth experienced in the economy determines the country's stable situation. A growing and progressive state of an economy may cause an increase in interest rates and similar demand for loans and mortgages and vice versa. Likewise, if the inflation rate is rising, the Fed interest rate forecast is higher, which puts pressure on the citizens to save more and take advantage of the higher interest rates. 

At times, central banks influence interest rates by introducing beneficial monetary policies in a quarter. Furthermore, events in other powerful countries can impact the upcoming bank interest rate forecast as well.

Various methods enable a near-to-accurate forecast for economists and policymakers. Let us look at them in brief:

Expectations theory

This theory uses long-term interest rates to predict short-term interest rates. It assumes that the investor earns the same return on two consecutive 1-year bonds as compared to a long-term 2-year bond investment. For example, a 2-year bond rate can be useful for forecasting the future one year. 

Economic models

With the help of various economic models, banks and economists can determine the long term interest rate forecast for next 10 years. A few of them include:

• Vasicek Model – single-factor short-term rate model for determining the direction of interest rates, 
• Hull-White Model – considers time-volatility also,
• Cox-Ingersoll-Ross (CIR) Model – uses market risk to monitor interest rate movements, 
• Vector Autoregression (VAR) Model – multiple factors like interest rates, inflation, etc., and other macroeconomic models. 

Yield curve analysis 

It considers the graphical representation of the relationship between interest rates and the maturity rates of different bonds. So, if the yield is moving upward, it indicates that the increase in the long-term forecast will be greater than the short-term rates. Such a situation provides an opportunity cost for lenders and similar risk from borrowers as well. Likewise, an inverted or flat curve makes short-term rates superior (increasing rates) to long-term rates, indicating low growth prospects and high inflation rates.    

Following are some instances that explain how such forecasts work in actual life. Let us look at them to understand the concept better:

Example #1

Suppose the Bank Reserve of Country XYZ has announced an increase in the basis points by 60 points in the second quarter of 2024. As a result, the lending rate rose to 8.6% and the deposit rate went up to 5.5%. Now, based on certain indicators, analysts and economists predicted an inflationary situation, indicating possibilities of a similar rise in the short-term and long-term interest rates. By the end of 2024, the central bank interest rate forecast was expected to rise by 25 basis points. However, this fluctuation would also cause the long-term rates for bonds to settle at a neutral state due to the chances of stabilization in the near future. 

Example #2

A September 2024 article mentioned that Bank of America is expecting the Fed interest rate forecast to go low by 25 basis points thrice in 2024 during each of the three remaining policy meetings this year. This decision of the BofA came following the release of the US employment data, which reflected a very low rise in employment figures. The forecast revealed was the same as that of multiple other WallStreet brokerages. 

In another recent meeting, held on September 18, 2024, the BofA raised its forecast to cut interest rates to 75 bps. Moreover, the brokerage also indicated an expected rate cut to 125 bps in 2025 to stabilize the Fed's terminal rate.

Interest rates and their related forecast serve a pivotal role in the policy-making process. It also helps businesses in making capital and debt-related decisions for the future. However, there are other benefits available to the economy as well. Let us understand them:

• Investment 

Such forecasts help investors determine the potential returns on bonds held in their portfolio. Any expected rise or fall in rates can influence the interest receivable on them. Similarly, they can predict stock market performance. 

• Consumer spending 

Changes in interest rates can also impact and influence the consumer's borrowing and spending habits. Any prediction of higher interest rates can lead to barriers to obtaining credit. As a result, borrowers can determine the cost of borrowing with this forecast. 

• Exchange rates

To a certain extent, even exchange rates are reliable on interest rates. Higher interest rates potentially attract investment from foreign investors, which in turn increases the exchange rate as well. 

• Government Decision-Making

The forecasts made on interest rates assist the government, central banks, and policymakers in monetary policy decisions. With the help of macroeconomic factors, it is possible to detect inflationary or recessionary situations and increase or decrease rates.