In this article i’m going to answer the question, how do changes in interest rates affect the stock market. I’m going to focus on decisions by the FEDS but this will equally apply to changes by the Bank of England and other similar organisations. Let’s get straight into it!
How do changes in interest rates affect the stock market – let’s start with the basics!
First of all, when we talk about ‘how do changes in interest rates affect the stock market’, which interest rates do we mean, and who changes them, and why? The interest rates I’m talking about in this article, are the ones set by the institutions such as the Bank of England or the FEDS (Federal Reserve Bank in America). These organisations change the interest rates to try and control the economy and often inflation. They can change spending by businesses and the public by changing the rates. For example, when your mortgage goes up due to a change in rates, you have less disposable income, right? The same is true for businesses – they tend to borrow for business purposes, and this affects how much profit they can retain, reinvest and use to grow. If inflation is spiraling out of control in the economy, these organisations can increase the rates to slow the economy down. Let’s take a look in more detail, at some of these scenarios.
How do changes in interest rates affect the stock market – An increase to rates – the purpose and effect
When the FEDS increase the interest rates, it raises the cost of borrowing for individuals and businesses. Borrowing for mortgages, and business loans become more costly. This has the effect of slowing down the economy and the outflow of this is that inflation is being controlled – which is the purpose. The economy is slowed because of the lack of buying power on the part of the people and businesses who are paying the debts and this results in less sales for businesses and slower economy growth.
The effect on the stock market is that the investors will now be worrying about a lack of growth and they will switch their money out of stocks, into something more steady (but which attracts slower growth) like bonds.
What about a decrease to interest rates?
The opposite is true for a decrease to rates. With a decrease to rates, people and businesses have more disposable income. Businesses are able to make more investment into growing the business which in turn, can make more profit. People can spend more due to the increase in disposable income and they therefore buy more product, being produced by the businesses, and this in turn leads to more growth still.
How can I take advantage of these changes when trading or investing in the stock market?
You can keep track of when interest rate decisions are going to be announced on the Federal Reserve Bank’s website, and the Bank of England’s website, and take note of whether the rate has increased or decreased and, therefore, how this will affect the stocks. I have published a separate page detailing links to the calendars noting the dates on which these organisations will next be making these decisions, here:
I hope you found this article helpful!
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