The Impact of Interest Rates on the Stock Market

Players in the investment community and the financial media are always keen on interest rates. Every time there is a change in the rates, whether positive or negative, the effects are not just felt by those who are directly involved, but they tend to ripple across the entire economy.

Though it may take some time before the economy feels the effects of the change, the stock market usually responds immediately. The knowledge of the relationship between interest rates and the stock market is thus vital to every investor, since it will impact their investment decisions, and their overall lives.

The government uses interest rates to control inflation rates throughout the country. When the government raises interest rates, it is trying to shrink the supply of money available in circulation by making it money more expensive or difficult to acquire.

Conversely, when rates are decreased, the government is trying to increase the money supply, hence, making it cheaper to get or borrow, and this encourages people to spend more.

Rates and the Stock Market

When a company is making fewer profits or reduces their expenditure on growth, then the amount of their future cash flow will go down. If all things remain constant, the prices of the company’s stocks will go down.

If more companies experience a decline in their profits, the key indexes or the entire market may also go down. This is due to investor uncertainty regarding future cash flow, and the growth of the companies, making it less desirable to continue investing in the affected stocks.

However, not all sectors of the economy get hit when the rates go up. Mortgage companies, brokerages, insurance companies, and banks tend to benefit when interest rates go up. The high interest rates charged by lenders generally results in more profit.