What is the impact of an increase in interest rates?

The impact of interest rates is trifold. Firstly, interest rates affect the cost of borrowing and the return on savings. An increase in interest rates is likely to make borrowing more expensive, as now a bigger percentage of the loan initially made should be paid back. Moreover, an increase in interest rates, is likely to increase the return on savings, as money deposited in the bank will get a bigger percentage back. Furthermore, interest rates have an impact on the exchange rate. This is because an increase in interest rates, is likely to attract more people internationally, to deposit their money in the country's banks, since they offer a greater reward. The so called 'hot money' is likely to increase demand for the country's currency, thus pushing up the exchange rates, leading to an appreciation of the currency. Taking this a step further, an appreciation of the exchange rate, is likely to make imports cheaper, in domestic currency terms, and exports more expensive in foreign currency terms. To use an example to illustrate this, lets assume that previously 1£=1$.Lets say we (UK citizens) wanted to buy imports worth 100$, we would have to give out 100£ to do so. If there is an appreciation of the exchange rate, however 1£ would now be worth more dollars, e.g. 1.10$. Therefore to buy imports worth 100$, we would now only need 90.91£ to do so (100/1.1), making imports cheaper in domestic currency terms. On the other hand, if we wanted to sell our exports worth 100£, a US resident would previously need 100$ to do so. However now, he would need 110$ (1.1*100) to do so, making our exports more expensive in foreign currency terms. If this is hard to understand, an easy way to remember this is by the acronym SPICED, which stands for strong pound, imports cheaper , exports dearer!