What is Benchmark Interest?

What is Benchmark Interest?
The benchmark interest rate is the reference point for interest rates in an economy. The benchmark interest rate, which is determined as a result of the supply and demand of government bonds in the secondary market, is a reflection of the set of monetary and fiscal policies in the relevant country, macroeconomic - political - geopolitical developments and the risk perception towards the country on the market. In this article, you can find answers to the questions what is the indicator interest, what is it for, why does it vary, what are the consequences of the increase and decrease of the indicator interest rate.

Indicator interest is one of the parameters used as an important indicator in financial markets, providing information about the whole economy. The benchmark interest rate, also called the market interest rate, is also used to determine the interest rate of other financial products.

Benchmark interest is the price of government bonds in the secondary market. The price in question, that is, interest, is freely determined by market participants according to supply and demand. Therefore, it has the function of reflecting the realizations, expectations and risks in the relevant economy.

Instruments used as benchmark interest rates vary depending on market and liquidity conditions. In Turkey, the interest rate in the secondary market of the government bonds with the highest liquidity, which have two years left to maturity and make coupon payments in 3 or 6-month periods, serves as the benchmark interest rate. On the other hand, in the USA, the interest rate of 10-year government bonds is taken into account as the benchmark interest.

Indicator interest and policy interest are concepts that are confused with each other. The benchmark interest rate is determined freely in the secondary market according to supply and demand, while the policy interest rate is determined by central banks. Central banks aim to direct the money supply and short-term interest rates through interest rates. Central banks determine the interest rates for short-term loans given to banks to provide the liquidity they need and for borrowing to attract excess liquidity. Central banks aim to influence the general level of economic activity and prices by determining the interest rate. Therefore, this interest rate is called the policy interest rate. The policy interest rate used by the Central Bank of the Republic of Turkey (CBRT) is the interest rate applied in one-week repo transactions. Decisions regarding policy rates are taken by the Monetary Policy Committee (MPC). However, the actions of central banks can also indirectly affect the benchmark interest rate.

What is the Use of Indicator Interest?

The benchmark interest rate is one of the important indicators reflecting the economic situation in the relevant country. It is a reflection of market expectation. The set of monetary and fiscal policies in the relevant country, macroeconomic - political - geopolitical developments and risk perception towards the country - credit rating is the pricing of the whole in the market. The benchmark interest rate, also called the market rate, reflects the borrowing cost of the relevant country. It serves as a reference interest rate for interest rates on other financial instruments.
Why Do Benchmark Interest Rate Changes Happen?

In countries providing resources with external financing; An increase in the money supply may cause a deterioration in exchange rate and therefore inflation-related expectations. Therefore, an increase in the benchmark interest rate may be observed. In other words, rising inflation may reduce bond yields and, in turn, reduce the demand for bonds, i.e. increase the supply of bonds. If the bond demand decreases (bond supply increases), the benchmark interest rate will increase.

It is not possible for the benchmark interest rate to rise or fall for just one reason; it is affected by many factors. Increasing bond yields in global markets, especially in developed countries, changes in the country risk premium called CDS (credit default swap), higher interest rate increases by leading central banks, structural problems in the relevant country, political and geopolitical developments, increase in energy prices, central banks in the same country group banks increasing interest rates, etc. Factors such as this cause the benchmark interest rate to fluctuate.

What are the Consequences of Increase and Decrease in Benchmark Interest?

Declining benchmark interest rate; It may indicate that market conditions are optimistic, there is confidence in the economy, and inflation expectations are improving. Borrowing costs fall. In this case, consumption increases and economic growth can be stimulated. On the other hand, the decrease in the benchmark interest rate means that the demand for government bonds, especially from abroad, is increasing. This means that foreign currency enters the relevant country. On the other hand, as the benchmark interest rate decreases, an increase can be observed on the stock market side.

Investors shape their investment decisions based on the benchmark interest rate. Government bonds are generally considered low-risk and highly liquid investment instruments. During recessions, government bonds can be preferred as a low-yielding but safer investment tool. In periods when the benchmark interest rate is low, returns decrease and investors' risk appetite increases. Rising risk appetite causes investors to turn to riskier assets such as stocks rather than government bonds.