How Lower Interest Rates Can Give the Auto Industry a Boost

The auto industry is a major sector of the economy, producing millions of vehicles each year and employing hundreds of thousands of workers. Like any industry, the auto sector is impacted by economic conditions and policies set by the government and central banks. One policy lever that can strongly influence the auto industry is interest rates – specifically the interest rates charged by banks and lenders on loans made to auto companies. Lowering these interest rates can provide a helpful boost to the auto industry during difficult economic times.

Why Do Interest Rates Matter for the Auto Industry?

Auto manufacturers rely heavily on loans to finance their operations. They utilize loans to cover the costs of building factories, purchasing equipment, hiring workers, developing new vehicles, and more. The interest paid on these loans impacts the bottom line and profitability of auto companies.

Higher interest rates increase borrowing costs and can squeeze margins. However, when interest rates decline, it becomes cheaper for auto companies to access the credit they need to invest and expand. This gives them more financial flexibility.

Additionally, the interest rates charged to customers purchasing new vehicles also tend to track the overall level of interest rates in the economy. Lower rates make it less expensive for consumers to secure auto loans, increasing demand for new cars.

How Central Banks Influence Interest Rates

The primary lever for impacting interest rates in the economy is the central bank. In the United States this is the Federal Reserve. The Fed directly sets the Federal Funds Rate and Discount Rate. While not all loan rates are directly tied to these benchmark rates they influence the general level of interest rates across the financial system.

When the Fed cuts rates, it motivates commercial banks to lower their prime rates and the interest charged on variable rate loans. Fixed rate loans also tend to be issued at lower rates when the Fed is pursuing an expansionary, low-rate policy. This Expanding the money supply through quantitative easing can have a similar impact.

Through these policy actions, the Fed can indirectly reduce borrowing costs for automakers and consumers looking to finance vehicle purchases. This stimulates economic activity in the auto sector.

Historical Examples of Rate Cuts Boosting Auto Sales

There are several historical examples where deliberate Fed interest rate cuts aimed at supporting the broader economy also provided a clear boost to the auto industry:

• 2001 Rate Cuts Following Dot-Com Crash – The Fed aggressively lowered rates in 2001 as the economy slid into recession after the tech bubble burst. Auto sales and production rose steadily in response. Low rates kept automakers profitable despite the weak economy.

• 2008-2009 Cuts During Financial Crisis – To fight the Great Recession, the Fed took unprecedented action, cutting rates to zero. This helped drive a rebound in vehicle sales and production in late 2009 into 2010 as credit markets thawed. Low rates boosted lending to consumers.

• 2019 Rate Cuts – As economic growth slowed in 2019, the Fed cut rates several times. Auto sales were flat in 2019 rather than declining as expected. Cheap credit drove continued purchases. GM, Ford and Chrysler all benefitted.

In each case, the auto industry was a clear beneficiary of expansionary Fed policy and lower interest rates. This demonstrates the power rate cuts can have to stimulate economic activity in the auto sector.

How Lower Rates Can Help the Auto Industry Now

With high inflation and rising interest rates in 2022, the auto sector has begun to slow. Housing affordability is also declining, as mortgage rates increase in response to Fed hikes. This may cause consumers to pull back on big ticket purchases like new cars.

Targeted Fed policy to lower rates on auto loans could help offset this impact. Other options include government subsidies to automakers to lower borrowing costs for new factories and investment. Extending consumer incentives like low-rate auto loans can also spark demand.

Lower rates may not fully negate the economic slowdown underway, but can provide incremental support to sustain auto manufacturing, sales, revenues, and employment to the extent possible until conditions improve.

There are also ways that individual automakers can take advantage of lower rates:

• Refinancing Debt – Auto companies can refinance existing loans and bonds to reduce interest expenses if rates decline. This frees up cash for R&D and operations.

• Locking in Low Rates – They may issue new fixed-rate debt or loans to lock in lower rates for the long-term. This ensures low borrowing costs even if rates later rebound.

• Customer Subsidies – Automakers can directly subsidize interest rates or extend 0% financing offers to spark sales, made possible by their own low borrowing costs.

Risks and Considerations

There are some trade-offs policymakers must consider when reducing rates to boost the auto sector:

• May contribute to inflation if it over-stimulates demand across the economy.

• Benefits some industries like autos more than others. Could distort economic incentives.

• Reduces savers’ interest income as rates decline across the board.

• May encourage excessive borrowing and risk-taking when money is cheap.

• Loses effectiveness as a stimulus option if rates remain low indefinitely.

• Can incentive automakers to pursue share buybacks and dividends over long-term investments.

Despite these risks, lowering interest rates remains one of the most potent tools available for supporting the auto industry during periods of weakness. The benefits of keeping this vital sector stable and preserving jobs will often outweigh the costs.

Interest rates impacts on the auto industry are clear. When rates are lowered, it relaxes borrowing constraints on automakers and consumers, providing a boost to sales, production and economic activity across the sector. This was evident in the 2008 crisis and 2001 recession. As the economy faces new headwinds in 2022 and beyond, reducing auto loan interest rates can once again offer targeted relief to this vital industry.