Interest rate effect

How interest rates affect: Individuals, Businesses & the Stock Market?

Interest Rate Effect

Once Janet Yellen ended the QE program of the US dollar, Interest rate hike as a topic started to be the most popular topic on the investors tables. Interest rate effect is a dilemma for everyone because it affects every single part in the economy directly so, reactions are interchangeable, mixed and must be well-understood to know where is every local currency is moving. Basically, Interest rate is the cost someone pays for the use of someone else’s money

Away from complicated details, I will simplify the effect of this important term through the following explanation

Inflation Definition and Impact

Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services. Consequently, inflation reflects a reduction in the purchasing power per unit of money.

Central banks attempt to stop severe inflation, along with severe deflation, in an attempt to keep the excessive growth of prices to a minimum.

Interest rate adjustment is one of the powerful tools which is used to control the inflation/deflation by the central banks

Interest Rate Effect on Individuals

Individuals are divided into two major types:

  • – Money Owner (individual who has extra money amount to invest or to save)
    • Increase in interest rate for this type of individuals mean the followings:
      • – Saving money (especially in banks) becomes much favorable for the majority of investors. Banks saving accounts, treasury bills and bonds offer competitive returns with lower risk if compared to stock market returns. Everyone knows that stock market is a high risk market.
      • – Lower spending desire because, money-saving is much tempting
  • – Money Needy (individual who has no/low money fund to get his/her needs and demands)
    • Increase in interest rate for this type of individuals mean the followings:
      • – Banks loans, credit cards, credit allowances and mortgage are much expensive
      • – Lower spending desire because, cost of borrowing is higher and less income available

Interest Rate Effect on Businesses

Businesses have different types too however, the effect of interest rate can be explained as follows:

  • – Businesses have 3 majors areas that are directly affected with interest rate increment
    • – Lower demand on their services and products driven by lower spending behavior from individuals
    • – Lower demand on the business services and products means lower profits for the business and lower returns on their stocks too. Then, stock price falls affected by the lower returns.
    • – Higher interest rate means higher borrowing costs for the businesses. Usually businesses borrow to expand and develop their sizes and operations. Higher interest rate will eliminate the business from expansion and growth.

Interest Rate Effect on the Stock Market

Stock market is directly affected with interest rate as follows:

  • – Stock market is the interaction area between the investors and the businesses. Higher interest rate will affect the businesses as I’ve mentioned above and this will push the stock prices lower. When stock prices are lower, this means that the whole market declines and its index(es) fall. Investors want appreciation for their equities overtime and falling stock prices and indexes will threaten their equities appreciation and lower their desires to invest in the stock market.

Question: Higher interest rate is a stock market killer?

The answer is: BIG FAT NO!

However, Interest rate is a correction flag for any stock market and it clearly means that a major correction might be coming in the near future, keep your eyes opened!.

What is important to know is that: Quantitative easing and low interest rate encourage investing in stock market and usually, the stock market indexes make new highs during the low interest rate periods and QE programs implemented by the governments. But, This does not mean that with a higher interest rate, you must sell your stocks.

There are other important factors affect the stock market so, do not panic. Corrections and consolidations usually happen every year.

What’s important is to watch the economic data releases to see how the economy of a specific country performs and based on this, you can sell and buy stocks.

Remember to keep sharing the useful knowledge