This year, inflation and interest rates are a significant topic for the economy and crypto community. But how are they connected and what impact do interest rates have on cryptocurrency prices and the bear market?
When inflation rates tend to rise, the central banks usually increase interest rates in order to manage inflation. This leads typically to inflation and interest rates moving in the same direction with lags. But how can increasing interest rates have such an impact on inflation?
Higher interest rates lead to more expensive interest payments on credit cards and loans. The result is less spending and borrowing. People with loans have to spend more on interest rates, which leads to a less disposable income and a falling consumption as a result. Moreover, interest rates on mortgages increase as well, which have a significant impact on consumer spending.
On the other hand, higher interest rates make it more attractive to save money in deposit accounts as the return for savers increases. For companies, an overall low consumption rate could lead to decreasing sales. Higher interest rates affect investments, as consumers and firms are way less willing to invest, especially in (still considered) risky assets like cryptocurrencies. As cryptocurrencies are still high risk assets, the crypto community faces a bear market (falling prices overall over a multi month period of time).
Overall, higher interest rates tend to reduce consumer spending, which leads to a fall in aggregate demand and a decreasing inflation rate. Other side effects are slower economic growth, higher unemployment rates, and a possible economic recession. To avoid significant “damage” for the economy, the central banks have to handle interest rate hikes carefully and calculate possible outcomes with high accuracy.