This week, both UK and US central banks will vote on whether to increase their respective interest rates. Whatever the outcome, their decisions could have a big impact on the value of your stocks and shares.
So, let’s take a look at how an interest rate rise could impact the stock market.
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When will central banks meet to decide on interest rates?
The United States Federal Reserve will meet on Tuesday 15 March to decide on whether to increase interest rates. Currently, the base rate across the pond stands at zero, meaning financial institutions can lend to one another at no cost. If the US central bank decides to up interest rates, it will be the first time it has done so since 2018.
Even if you aren’t directly invested in US stocks and shares, the American economy has a huge impact on share prices around the globe. Don’t forget that the US dollar is officially the world’s reserve currency.
Meanwhile, in the UK, the Bank of England’s Monetary Policy Committee will make its decision on Thursday 17 March. At its previous meeting on 3 February, the bank decided to increase its base rate from 0.25% to 0.5%.
The UK’s central bank previously increased rates from its all-time low of 0.1% to 0.25% in December last year. The decision raised a few eyebrows at the time as many had expected the bank to sit tight until the new year.
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How likely is it that interest rates will rise?
Inflation in the US currently stands at 7.9% according to February’s figures. This is the highest rate the country has seen since January 1982. Meanwhile, the inflation rate in the UK is also soaring, but not quite to the same extent as it is in the US.
According to the Office for National Statistics, UK inflation is now running at 5.5% – a 30-year high.
Inflation is bad for the economy as it can add to economic uncertainty, devalue currency and even lead to hyperinflation if not addressed.
To curb inflation, the UK and US central banks have the power to raise interest rates. The theory is that by raising borrowing costs, spending is cooled, which should put the brakes on runaway inflation. However, interest rates can’t be hiked massively in one go as that could spark economic collapse. Instead, during times of rising inflation, central banks prefer to raise rates in small increments.
It’s worth knowing that markets expect the US and UK central banks to raise interest rates this week. According to the Financial Times, the US Federal Reserve is expected to up rates by 0.25%. Meanwhile, the Bank of England is also expected to up rates, possibly by the same margin.
Philip Shaw, Investec’s chief economist, suggests the Bank of England is likely to raise rates until it sees tangible results from its actions. He explains that the BoE “may well raise rates gradually until there are signs that the economy is slowing, that inflation pressures may be ebbing or that it is clear that pay growth remains relatively modest.”
How can rising interest rates impact the stock market?
In simple terms, when interest rates are lowered, the stock market generally edges upwards. That’s because businesses can benefit from lower borrowing costs that make it less risky to invest.
Lower interest rates can also make it possible for businesses to cut prices. This can boost both sales and profits, positively impacting share prices as a result.
Similarly, low interest rates can increase disposable spending among consumers. This again can boost spending in the economy, which is a positive for businesses, particularly those selling consumer goods.
However, when interest rates rise, the opposite can happen. That’s because higher lending costs can make businesses reluctant to invest. It also increases the cost of servicing debt.
Higher interest rates can lead to businesses having to hike prices. While some consumers may happily pay higher prices, others won’t be willing or able to. This can reduce sales, lowering profits, which can negatively impact the value of shares.
Importantly, the impact of higher interest rates can vary from sector to sector. For example, banks often do well when interest rates are high.
As a result, the concept that higher interest rates are bad for the stock market should only be considered as a ‘rule of thumb’. That’s because if you invest in individual stocks, it is possible for your portfolio to benefit from higher borrowing costs.
For more insights on this, see our article that highlights two FTSE 100 stocks that could rise if interest rates go up.
The post If the base rate rises this week, how will it impact the stock market? appeared first on The Motley Fool UK.
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