Hahaha how did you know!
Actually I've been asked about the impact of interest rates a few times during interviews, would you mind explaining what the consequences are? And how does it impact law firms?
I understand that interest rates has something to do with exchange rates and inflation but I'm confused to be honest.
Ok so this question seems to be a favourite at assessment centres this year. I’ll try to give a quick run through of the main issues. There’s plenty of things I’ve missed out so I may cover this in a future guide.
Who is raising interest rates?
That’s the central bank. Almost every country in the world has one. We’ll focus on two – the Bank of England in the UK and the Federal Reserve in the US. Right now, when you see the press talking about the ‘Fed’, that’s just short for the Federal Reserve.
When the central bank raises interest rates, it becomes more expensive for banks to borrow money. As a result, banks will often raise interest rates making it more expensive to borrow for everyone else.
The central bank has a few functions, I’ll focus on inflation. Inflation is the rise in prices of goods and services over time. If inflation increases, it erodes the value of money. That means it costs more to buy the same amount of goods and services.
So rising inflation is bad and central banks are there to stop that. They can raise interest rates to slow down economic activity and stop inflation rising too fast.
Why are they raising interest rates this time?
First, it’s important to remember that interest rates have been really low for a long time. That was in order to stimulate growth after the financial crash.
At the moment, the US economy is doing well. It’s seen wage growth and low unemployment rates. When the economy is growing and wages are growing, that’s usually a sign of inflation. There’s also a new chair of the Federal Reserve, it used to be Janet Yellen and now it’s Jerome Powell. Markets have been a bit crazy for a while because they don’t like uncertainty. With a new chair, investors are looking to see how he feels about the economy.
Consequences and Impact on law firms
Borrowers in emerging markets will be hurt because they have plenty of bonds denominated in US dollars. You may see that referred to as dollar-denominated debt. If interest rates rise, investors are also likely to flock to the US. That’s because bonds issued by the government will pay more interest (which is good if you’re an investor. If I wanted to link that to a law firm, I could talk about the global reach of a law firm. I’d think about how its restructuring or insolvency practice will thrive in emerging markets.
Companies with lots of debt could go bust or need to restructure. If there’s a slowdown in economic activity and companies aren’t borrowing, I could say we might see less work for finance and M&A teams in the US. It might also cause our central bank governor, Mark Carney, to think about raising interest rates.
Having said that, I’d note that the UK picture is different. Whilst our target is 2% (and inflation is currently higher than that), we’ve also got Brexit to deal with. It doesn’t make much sense to raise interest rates when the markets are already troubled.
