+91 95618 61818
Stock prices and interest rates share a close relationship. Think of them as the dance floor and music. The way music sets the rhythm and makes everyone move to it, interest rates affect stock prices and influence the stock market and stock investor’s investment decisions.
But how do interest rate variations cause stock market upheavals?
Learning about this relation should interest you as a novice stock market investor, pursuing or about to pursue stock trading classes in India. So, let’s overview it in this blog.
What are Interest Rates?
Interest rates refer to the cost or return you earn when you lend money.
In simpler words, they are the percentage you earn on a particular loan or the percentage you earn on your investments or bank deposits.
A country’s central bank (for example, in India, the Reserve Bank of India) sets the interest rates. When RBI decreases or increases the interest rates, it impacts how cheap or expensive borrowing money becomes for consumers and businesses.
Thus, higher interest rates make borrowing more costly, decelerating spending and investments. On the other hand, lower interest rates make borrowing cheaper, encouraging people to spend and invest more.
Stock prices reflect a company’s future earnings and growth potential. Thus, interest rate changes impact investor sentiment and company performance, affecting stock prices.
Impact of Higher and Lower Interest Rates on Stock Prices
Higher interest rates usually put downward pressure on stock prices. Let’s delve more.
- Increased Borrowing Cost: When interest rates increase, businesses must pay more on loans and credit lines. It increases operational costs and lowers profitability, resulting in lower stock evaluations.
- Customers Spend Less: As borrowing becomes expensive, consumers spend less. It affects company revenues, especially for those across consumer-driven sectors.
- Fixed-Income Investments Surge: Higher interest rates make FDs and bonds more attractive as they deliver higher returns. Accordingly, you would see many investors switching from stocks to bonds. This move pushes down the demand for stock and depreciates stock prices.
For example, if RBI increases interest rates, sectors like real estate and automobiles that depend heavily on financing may see profits declining considerably. In situations like these, investors might sell their stocks, resulting in a price drop. Generally, during high interest rates, consumption based shares gain – which is the situation right now. That’s because people concentrate on buying essential items required for daily needs and tend to avoid unnecessary expenses on luxurious things.
Now, let’s see what changes lower interest rates cause in stock prices.
So, lower interest rates typically increase stock prices. Here are some reasons for this.
- Cheaper Borrowing for Companies: Lower interest rates reduce capital costs, enabling companies to borrow more at lower costs. This proves to be conducive to business expansion, increased profits, and stock valuations.
- Higher Consumer Spending: Lower rates reduce EMIs. People are then left with more disposable income. Thus, they spend more. Demand for goods and services increases, helping drive company revenues and stock prices upwards.
- Fixed-Income Investments Fade Away: Lower interest rates make bonds and fixed deposits less attractive. Then, these options deliver a lower yield, encouraging investors to turn to stocks. This results in an increase in the demand for stock and a considerable price appreciation.
Looking at the same example, when RBI slashes the interest rate from say 7% to 6.5%, real estate and automobile companies benefit as people turn to finance to purchase these products. Hence, the stock prices of such companies increase with this change.
What Makes the Stock Market Sensitive to Interest Rate Changes?
One reason for this is that stock markets are forward-looking. It means, investors always try to forecast things. The moment central banks announce interest rate changes or hint at it, markets begin reacting to the change. Thus, if the bank hints at an interest rate hike, stock prices might plummet even before the change is official. On the other hand, if the bank indicates a cut in the interest rate, stock prices begin soaring!
Tips to Invest During Interest Rate Changes
As an investor, you cannot control interest rate changes at the macro level. However, you can tackle them effectively by investing sensibly and thoughtfully. Here’s what you can do.
Rising Interest Rates: Focus on sectors like healthcare, utility, etc., with steady demand.
Falling Interest Rates: Invest in growth stocks in real estate and technology.
Note: The above is generic advice. We recommend making an informed investment decision after a comprehensive market analysis and based on your financial goals.
Don’t Let Interest Rate Changes Surprise You! Learn Proven Investment Strategies Today – Secure Your Spot in Our Expert-Led Course!
Want to Deal with Interest Rate Variations Confidently?
Then, join EMS – a reliable stock market institute in Pune. In simple words, we teach you how to make educated and sensible decisions amidst the dynamic environment. We have designed our courses to help you gain practical knowledge, tackle changes effectively, diversify your portfolio, and become a confident stock investor.
Thousands trained already and counting! Call us at +91 95618 61818 to learn more.
