What is the Impact of Inflation on Interest Rates?

Bank Interest Rates

The Philippines is currently experiencing a relatively high increase in inflation which is primarily due to an increase in the prices of global non-oil commodities. These commodities include agricultural goods and metals, a prolonged scarcity of domestic pork supply, higher seafood prices, and increasing hikes in jeepney fares price because of increased rates of oil. Per recent reports published last February 10, 2022, in the United States of America, the price of gasoline was up 40 percent in January 2022, while used cars and trucks were up by 41 percent compared to last year. Other aspects enduring high inflation include hotel establishments, eggs, and oils or fats, which are up by 24 percent, 13 percent, and 11 percent, accordingly. Prices rose about 7.5 percent on average. This had been reported to be the swiftest rate of inflation as of the year 1982. All whilst, a delayed global economic recovery in the Philippines, as well as the possibility of reimposing quarantine provisions due to the national re-emergence of COVID-19 cases in the Philippines, may decrease demand and slow inflation. Currently, inflation-adjusted living costs are at a 40-year steep and steadily increasing. Inflation is soaring to much higher levels than we have seen over the last three decades. In June, headline inflation rose to 6.1 percent annual growth, up from 5.4 percent over the previous month. This was within the Bangko Sentral ng Pilipinas’ (BSP) monthly forecast range of 5.7-6.5 percent. The derived average inflation of 4.4 percent in the first half of 2022 is significantly higher than the current administration’s expected range of 2.0-4.0 percent for 2022. Furthermore, experts predict inflation to be significantly greater than the expected range in 2022, according to the BSP’s survey of private sector economists for May 2022, due to the enduring Russia-Ukraine dispute that elevates global oil and food prices. For the time being, inflation is projected to be close to the target in 2023 before slowing down in the year 2024. Most analysts anticipate that the BSP will begin tightening policy and boosting the key policy rate in the 2nd quarter of the year 2022. This article will help you understand the effects of inflation most specifically on interest rates.

What is Inflation?

Inflation is defined as a sustained increase in the overall cost level of goods and services in an economic system. It is equivalent to a deficit of purchasing power for a currency used in a specific economy. As a result, it takes more currency units to purchase the same quantity of goods and services over time. Your money buys less, whether it’s pastry, laundry detergent, rent payment, and even basic healthcare.

What are the effects of inflation?

When prices of goods and services rise faster than wages, this results in a loss of purchasing power. It forces people to spend more pesos, or other currencies to purchase basic needs, which may also put the average consumer in a tight spot. It can also significantly decrease discretionary spending. For example, by September 2022, you would have had to pay Php 150.00 to purchase a full meal in a fast food restaurant which could have been bought for Php 99.00 last September 2021. On the other hand, people may stop or reduce their spending if inflation is too low, or even negligible because they expect the cost to continue falling. So if people stop wanting to spend, businesses may fail and a lot of individuals may lose their livelihood or jobs.

Inflation is caused by either an increase in demand or a decrease in supply. However, because there are multiple economic situations and considerations that can move either of these factors, pinpointing the exact cause of inflation is not so easily distinguishable. At any given point in time, inflation can be caused by a combination of economic and regulatory forces.

Higher inflation directly impacts every aspect of our lives, from weekly grocery shopping to your daytime commute to and from work. But even so, one of the aspects it has the most implication over is interest rates. Interest rates and inflation affects our daily lives, from how much money we can borrow for a loan to how much our weekly food costs.

What are Interest Rates?

The percentage charged on the entire value borrowed or obtained on the total amount saved is regarded as interest. Accounts that provide a platform to save or borrow money are likely to have an interest rate.

Just about all banks in the Philippines will pay you interest rates on your savings accounts if you keep your money with them. If you have a bank loan, you will almost certainly be charged interest on your loan. You will generate more if the interest rate on your savings account rises. However, if it rises on borrowed funds, you will be charged more.

How does Inflation affect Interest Rates?

Central banks, such as the Philippines’ Bangko Sentral ng Pilipinas (BSP), use interest rates to control inflation. Inflation and interest rates are inextricably linked. When the inflation rate is soaring, interest rates are higher as well. Moreover, interest rates typically fall when inflation is low.

  1. How does high inflation affect interest rates?

One way to combat high inflation is to raise interest rates. Cost of borrowing rise when interest rates go up. This makes borrowing unaffordable. As a result, borrowing will decrease, and the money supply– the amount of cash in circulation– will drop. When the money supply declines, people will have less spending power. As a result, they will buy fewer goods and services. Consequently, demand for goods and services will fall. With supply remaining unchanged and demand for goods and services dwindling, the cost of goods and services will collapse.

  1. How does low inflation affect interest rates?

When inflation is low, the interest rate is decreased. Borrowing will become more affordable as inflation and interest rates decline. As a result, borrowing will rise, as will the money supply. Citizens will have more spending power and services as the money supply expands. Consequently, when demand for goods and services rises while supply remains unchanged, this will result in an increase in the cost of goods and services, also known as inflation.


Inflation and interest rates tend to follow the same route, but with delays. This is because policymakers need sufficient data to forecast future inflation trends, and interest rates take time to completely impact the economy. Higher rates may be required to control rising inflation, whereas slowing economic growth often brings down inflation and may even stimulate rate cuts.

Because interest rates affect the amount you can earn by lending money, bond pricing, and the amount you will have to spend to make loans, it is critical that you understand how these change. Adjustments in interest rates are primarily due to supply and demand forces, which are also influenced by inflation and the governing monetary policies. Most importantly, when making a decision on whether to put money in a bank or debt security, you should first fully comprehend how its features influence the type of interest rate you can obtain.

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Written by: MC Sanchez