Interest rates forecast: what rate rises mean for crypto

The interest rates forecast is looking gloomy. What might this mean for crypto markets?

Representative image of a hand pointing to the words “interest rates”                                 
What do rising interest rates mean for crypto? – Photo: Shutterstock
                                

Many investors are keeping a close eye on the interest rates forecast. The coronavirus pandemic led to unprecedented intervention from central banks around the world, with many unveiling ambitious stimulus packages in an attempt to stop their economies from collapsing.

Across many major economies, the interest rate forecast for 2021 is likely to be unchanged from current levels. The Bank of England’s base rate stands at 0.1%, and has been stuck there since March 2020, while the US Federal Reserve is holding steady at 0.25%. Over at the European Central Bank, interest rates have been at zero since October 2016, long before Covid-19 even made its presence felt.

Why interest rates matter

Interest rate projections matter because they can have huge ramifications for everyone. While an increase is typically good news for savers, because they receive a greater return on their capital, it puts borrowers under strain. Homeowners who have mortgages with variable interest rates can also see their monthly repayments rise substantially, and it may become more expensive for businesses to service any debt they have taken on during periods of growth.

So why were interest rates low during the pandemic, and what effect has this had on the economy? The Bank of England explained that its decision to cut the base rate to 0.1% was intended to “reduce the costs faced by businesses and households in the UK”. This was coupled with additional funding to ensure smaller companies could access financial support if demand for their goods and services was affected by lockdown restrictions.

When it comes to the future of interest rates, a number of central banks have made it clear that rates will not remain near zero for long. That’s because managing a country’s economy is like spinning plates – just as one is brought under control, another comes dangerously close to smashing to the floor.

Rising inflation

The past few months have seen inflation start to creep up, meaning that the cost of everyday items has begun to increase.

Inflation can be a good thing in small doses, but can greatly erode a consumer’s purchasing power if it happens too fast. Generally speaking, the sweet spot is at 2%, and in the UK, the Bank of England’s governor has to write a letter to the chancellor explaining what’s gone wrong if this target is missed by more than one percentage point either way.

How is the inflation rate faring in the West’s powerhouse economies compared to this 2% target? In the latest figures, which cover August 2021, the US saw a year-on-year rise of 5.3%, while the UK hit 3% after the largest month-on-month increase ever recorded. Continuing the theme, inflation in the eurozone is expected to reach 3.4% in September, racking up a 13-year high in the process.

Many of those making interest rate predictions believe central banks will need to raise their rates in order for prices to cool down. That said, increasing the cost of borrowing too quickly could have consequences of its own, making repayments unaffordable for millions.

The interest rate forecast for the next five years could also have an interesting effect on demand for cryptocurrencies, such as bitcoin and ether, as we explain in detail below.

FAQs

When it comes to the interest rates forecast, many central banks do offer short and medium-term forecasts, giving us an insight into how they think the next few years will pan out. 

In June 2020, most members of the US Federal Open Market Committee, which is responsible for setting interest rates, predicted that interest rates would begin to increase from 2023 onwards. But the consensus had shifted by September 2021, and now, a rate rise could happen as early as the middle of next year.

Meanwhile, the UK’s Daily Telegraph recently spoke to Michael Saunders, who sits on the Bank of England’s monetary policy committee. He urged British households to prepare for “significantly earlier” interest rate rises than first thought, with financial markets reportedly pricing in an increase to 0.75% by the end of 2022.

In contrast, the outlook of Fitch Ratings is that the European Central Bank’s key interest rates will remain unchanged until 2025.

The crypto markets are often very receptive to macroeconomic developments.

Given that low interest rates can offer disappointing growth on savings, some investors may be tempted to switch their attention to asset classes that could offer healthier returns. Research from the New York Digital Investment Group suggests that bitcoin is the best-performing asset class so far in 2021. BTC’s gains of 49.1% are streets ahead of commodities, equities and bonds. Of course, past performance is no guarantee of future returns and prices can go down as well as up.

Another crucial narrative relates to inflation. Quantitative easing policies involve increasing the circulating supply of dollars, pounds and euros, diminishing the value of those currencies. Bitcoin’s supply is fixed at 21 million and cannot be increased, meaning that a growing number of investment banks and analysts regard it as a digital store of value.

Historically, gold has served as a hedge against inflation. But according to JP Morgan, institutional investors are beginning to favour the world's biggest cryptocurrency instead.

In a note to investors on 6 October, analyst Nikolaos Panigirtzoglou said “the failure of gold to respond in recent weeks to heightened concerns over inflation” may have contributed to rising inflows. And while BTC’s market cap stands at about $1trn (£735bn) as of 11 October, gold’s is closer to $11trn. Ironically, the American bank’s own CEO disagrees with this analysis: Jamie Dimon has repeatedly argued that Bitcoin is worthless and has no intrinsic value.

A number of crypto enthusiasts, including billionaire twins Cameron and Tyler Winklevoss, have repeatedly argued that bitcoin has the potential to equal or surpass gold’s market cap in the coming years, an achievement that would take its per-coin price beyond $500,000. 

Others, however, disagree. Pantera Capital's Dan Morehead, for instance, believes the era of big bull markets is over and that “the amplitude of price swings will moderate” as the market widens and more institutions gain exposure to cryptoassets.

Tepid returns on cash sitting in a bank have also fuelled interest in crypto alternatives.

Staking involves locking up digital assets for a predetermined period of time, and earning additional tokens as a reward for doing so. This activity tends to have one of three purposes: providing liquidity to crypto traders, lending coins to others, or helping to keep a network secure by verifying transactions.

In some cases, staking is advertised as providing crypto interest rates of 5% APY (annual percentage yield). While this is a healthier return than traditional saving accounts can offer, it does come with the added risk of volatility, and any gains could be offset by a fall in the value of the digital asset in question. Staking on blockchains such as Ethereum also means an investor’s capital can be slashed as a penalty if they are seen to be acting against the network’s best interests.

There are also regulatory question marks over staking. Coinbase was recently forced to abandon plans to offer 4% interest on USD Coin, a stablecoin pegged to the US dollar. According to Coinbase, the crypto company received a Wells notice from the US Securities and Exchange Commission outlining its intention to sue Coinbase if it launched the coin.

Further reading

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