Introduction
Interest rate is a percentage of the total amount of money that a person or organization took as a loan. The rates of interests that a country or a bank bases it rates depend on the standards set by the central bank of the country or of a union. The interest rates used by the member countries of the European Union are under the control of the European Central Bank or the ECB.
This is an institution in charge of the monetary policies in the union. The European central bank is also in charge of stabilizing the interest rates of the member countries, keeping the inflation rate at a low level and ensuring that the foreign money reserves are stable. It acts as a last resort for lending money to its members’ banks.
The bank managed to maintain the lending rates to its members stable until 2010 when it resorted to saving some of its member states from foreign debts. Greece was also a target of European Central Bank had to save from sovereign debts by buying the debts and paying them off. This led to instability in assets and liabilities of the European central bank. This forced the bank to increase its lending rate in an effort to maintain stability in the European Union Market.
Canada’s rates, on the other hand, are under the control of the Bank of Canada which is Canada’s central bank. The bank was not originally there, but began its operation in 1934 due to an act of parliament that led to its creation.
The bank lends money to banks and institution as a last resort and acts as a central reserve for Canada’s money. Like the European Central Bank, the central bank of Canada also focuses on maintaining a low inflation rate. It also concerns itself with the maintenance of a stable financial state, effective control of the countries foreign debt and provision of valuable currencies.
The bank achieves all his by having the absolute control of the countries’ borrowing and lending rates. However, this power is applicable only to exceptional circumstances, and the central banks rely heavily on the foreign market exchange rates and demand for the Canadian Dollar to control its interest rates, (The Coming Depression Editorial Staff, 2009, October 9)
Effects of the financial crisis
The interest’s rates in the European Union have been under the control of the European Central bank, which acts as a central reserve for all funds in the Union. The central bank has successfully been in control of inflation and interest rates until the 2008 financial crisis that hit the some of its member countries.
The crisis forced the European Central Bank to review some of its policies, and save the other countries from sinking into the crisis with the other countries like Spain, Greece and Portugal. The union was in a tight spot because its members use the assets of the European Central Bank as securities to borrow money. This means that all members are at stake if the other countries are unable to repay their debts.
The European Financial Stability Facility got incorporated in to the union to help the countries in a financial crisis to service their debts. The European Central bank resorted to increasing its lending rate to the central banks of the member countries from 1% to 1.25%. The move aims at improving the value of the euro in the foreign market leading to increased foreign investment in the Europe zone. This will be a boost to the economy of the member countries that got badly hit by the financial crisis.
The effect of the increased rates in Europe is an influx of investors into the market. The result of the increases in Europe will be a decreased in foreign investments, in the United States of America that will lead to a drop in the price of the dollar, ( Neate, Farrer, Batty, 2011, December 8). The rise in the interest rates in the European zone is also crucial in making their goods more affordable than those of the other key players in the market, like the United States of America.
People will buy their products leading to a high foreign income will lead to an improvement of the country’s economy. However, the interest rates did not remain at the 1.25% mark for long because the European central bank cut it down again to 1% on 8th December 2011. The move aims at speeding up the growth rate of the economy, (Vancouver bc, 2012 September 2).
Canada, on the other hand, is also sinking into debt due to its low interests on the lending rate to households. This is according to statistics done by the Canada statistics department. The report stated that Canada was sinking in to debt in the first three months of the year.
The debt rose from the previous $1.526 trillion dollars to of $1.548 trillion dollars. This is as a result of favorable lending rates in the region. However, the low interest rates have led to accumulation of household debts. Therefore, the Central Bank of Canada will have to increase the interest rates on loans given to households in order to make the accumulation of debt more stable than it is now.
Bonds
Bonds play a key role in determining the rate of growth of the country’s economy. The European unions bonds have been increasing in the past few months. The meaning of an increase in the value of the bonds is a decline in the number of investors. This means that the European central bank has to shoulder the burden of paying the lenders the money owed by its member countries.
This has been a difficult task for Germany which is the only member of the Euro zone that did not suffer from the financial crisis. The German government failed to sell its bonds in the market making the situation worst. This is the cause of the appreciating interest rates that seek to attract more investors than when the interest rates are low, yet the bonds are trading at high prices, (Larock, 2011, November 28).
On the other hand, Canada managed to sell of its government bond. The bonds’ value was on the rise, but the situation is better when compared to that of the Euro zone. The country is in a better financial state when contrasted to the countries in the European Union.
The situation in Canada makes it the best option for investors as compared to the European zone where investors fear to invest their money to the high possibilities of losses. The Central Bank of Canada has to deal with a crisis as its interest rate is 0.5 %which is lower than that of the Euro countries.
Effects of interest rates in Canada
The difference between the interest rates set by the European Central Bank and the Central bank of Canada is a key player in the choice of investment site of most investors. This is because investors are more secure when investing in countries that have high interest rates than in countries that have a low interest rate. The cause of this preference is the value of the currency used in the country.
An increase in the interest rate means that the demand of the currency will rise due to the influx of foreign investors. The increase in foreign investors, in the country, will increase the need for the local currency which will automatically increase the buying price of the currency.
When comparing the interest rates of the European Union and the interest rates in Canada, it is evident that many investors will rush to the Euro zone to make their investments as compared to those who will invest in Canada. The result of the rush to the EU on the value of Canadian dollar is a fall due to its low demand in the market, (Langton, 2012, January 9).
Therefore, an increase in the interest rates by the European Union will affect the levels of foreign investments in Canada negatively. This is because many investors will not want to spend their capital in a country whose lending rate is low. However, an increase in the interest rates by the Canadian central bank will lead to a healthy competition for foreign investors with the European nations. This is because the difference in the lending rates will be minimal.
The high interest rates in Europe is more likely to affect the exports and imports in Canada from the European Union and exports to the union. The increase in interest rates in the European Union means that the Euro will trade at a higher price. This means that business people importing goods from the countries in the Euro zone will be spending more money buying goods than they were spending before the rise.
However, the business people in Canada in the export business will gain more profits as they will be selling their goods at lower prices in the foreign markets. This will lead to a higher foreign income from the sale of these goods. This will also affect the export business to these countries. This is because the business people will incur losses due to the high prices they have to incur while exchanging the Canadian dollar with the euro.
The difference will also affect the Canadians because of the low levels of foreign investments caused by the low lending rates. This will lead to an increase in the inflation rate in the country leading to lower wages. This means that the people who suffer from the difference in the interest rates are the low class citizens who depend on foreign investments for jobs and incomes. The inflation rates will continue with its upward trend unless the central bank does something to increase the interest rates that will attract foreign investors.
The increase of interest rates, in European nation, means that the dollar will depreciate making the prices of oil go up. This will make the cost of running businesses in Canada and any other country expensive. The increase in oil prices is due to the relationship of the dollar to oil; oil prices depend on the value of the dollar.
Many countries buy or sell oil using the US dollar. Therefore, a decrease in the dollars’ price in the foreign exchange leads to high oil prices. The business people will have to raise the prices of their products as they try to protect themselves from incurring loses.
Conclusion
The interests rates set by central banks of different countries have diverse effects not only on the internal environment, but also on the external environment. The financial crisis in Europe forced the European central bank had to relieve the member countries that sunk into debt, and could not afford to repay.
The bank had to reverse the situation, and one of the things it resolved to do was to increase the rates. This increase means that investors would rush to the zone to invest hence help increase the Gross Domestic Production in the affected countries. The effects of this increase were evident in the oil, and its by products which rose after the announcement, (Langton, 2012, January 9).
The rise in the interest rates also affected other countries like Canada whose interest rates are lower than that of the Euro zone. Many investors rushed to the European nations to make their investments leaving countries with lower interest rates behind. This also led to an increase in the value of the Euro meaning that businesses had to spend more money to import goods. However, the exporting businesses were at an advantage because they were selling goods at a cheaper price in the European markets.
References
Langton, J. (2012, January 9). Low interest rates impairing the outlook for insurers. Canada Mortgage News, pp. 34.
Larock, M. (2011, November 28). Mortgages and Finance, Home Buying. Morning Interest Rate Toronto Real Estate Blog.
Neate, R., Farrer, M., Batty, D. (2011, December 8). ECB cuts interest rates as crunch summit begins, New York News, pp 12.
Schultz, S. (2005, December 28). Calls made to strengthen state energy policies. The Country Today, pp 1.A.
The Coming Depression Editorial Staff. (2009, October 9).Canadian Interest rates set to rise in 2011.Economist. Under Creative Commons License,pp. 28.
Vancouver bc, Canada. (2012, September 2). ECB Keeps Interest Rate at 1%. Trading Economic, pp. 2A.EC