Business Studies – External Influence - Interest Rates And

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Business Notes Emma Rudd BMA
External influences
Interest Rates and Exchange Rates
Interest Rates
The bank of England is responsible for setting the base rate of interest. The Bank of
England's Monetary Policy Committee meets each month and takes decisions on
whether to alter the base rate of interest.
Changes in interest rates have significant effects on businesses and the
environment in which they operate. Recent UK governments have relied heavily upon
interest rates to control the level of economic activity in the economy and to avoid
the worst effects of the business cycle.
Interest Rates and Consumer Spending
Interest rates affect the level of spending by consumers. The level of spending is
dependent upon interest rates for a number of reasons:
Consumers are more likely to take a decision to save when interest rates are
rising. The return on their savings is greater and will persuade consumers to
postpone spending decisions. When rates are falling consumers may save less
and spend more.
Changes in interest rates alter the cost of borrowing. Many goods are
purchased on credit and if rates fall the cost of purchasing things on credit will
fall persuading more people to spend. Demand for consumer durables are
sensitive to interest rates.
Millions of UK consumers have mortgages. A rise in interest rates will increase
the amount paid each month by householders. This reduces the income
available to spend on other products and demand will fall. A fall in rates will
have the opposite effect.
Britain's population is steadily ageing, meaning that more people are
dependent upon pensions and savings. Pensioner's incomes are dependent
upon the rate of interest and thus their spending is sensitive to rate
Businesses and Changes in Interest Rates
Changes in interest rates also have significant implications for businesses. A rise in
interest rates will result in greater overheads for most businesses for example
increased interest chargers on any loans. When rates rise, firms might limit
borrowing (especially short term borrowing) but may be able to do little about the
increased costs of longterm loans. This means that businesses with high
proportions of longterm borrowing are likely to be hardest hit by rising interest
rates. It is small firms, however, who are often more affected by rising rates due
to their smaller financial reserves and greater need to borrow.
Firms may postpone decisions to buy new machinery or build new factories and
offices following a rise in interest rates. Business investment may fall because the
cost of borrowing money increases when rates rise. As a result, a previously
profitable investment may not be considered worthwhile. Firms may also be putting
off increasing their productive capacity in this way because they expect consumers
to spend less.

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Business Notes Emma Rudd BMA
If interest rates rise businesses save more, as returns are greater. Postponing
investment decisions will reduce the level of economic activity within the economy.
At times of declining interest rates businesses will increase their investment
spending as consumer spending is rising and more productive capacity will probably be
required. Decisions to invest may be postponed or abandoned because of the
increasing cost of borrowing. However, much investment if financed from retained
profits.…read more

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Business Notes Emma Rudd BMA
Exchange Rates
Exchange rates between most currencies vary regularly according to the balance
supply and demand for each individual currency.
Why do Firms Purchase Foreign Currencies?
The main reason businesses purchase foreign currencies is to pay for goods and
services brought from overseas. Firms purchasing products from abroad are usually
expected to pay using the currency of the exporting country.
Demand for foreign currencies may also rise because individuals and businesses wish
to invest in enterprises overseas.…read more


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