How does interest rates affect equity markets

How does interest rates affect equity markets

How does interest rates affect equity markets?

Interest Rate means the cost of borrowing funds. It is the payment made to the lender for the facility of using his money for our own purpose. Many times our spending decisions are also guided by the interest burden that we would be bearing but, more than the returns the major focus should be on real returns on our savings .Real return is interest rate less inflation. 

Even as consumers, interest rate are an integral part of spending habit because we borrow it from the bank for buying house, cars, house old items etc. For business purpose interest rate is important since it borrows money from bank for investment activities. Thus interest rates play a critical role in a business’s profitability and hence, on stock prices. The opportunity to earn higher returns at very low risk results in funds moving out of stock market affecting the stock markets adversely.

Companies with High debt

The immediate impact of rise in interest rate in the short term is on companies which have a high debt in their balance sheet .The interest payment made by company rises which reduces the EPS. Thus there would be negative effect for such stock which results into depleted stock price. When the interest rate is very low, savings would be less and consumption would be more. The fixed deposits don’t have longer attraction. Thus there would be fall in consumption & investment activities in the economy. The government in this situation would start to print currency in order to impart more money in the economy.  This would lead to inflationary situation in the country. Also, FIIs take their decision based on the basis of difference in interest rates between economies. There is likelihood of reduction in the Inflows can be due to the very low interest rate.

Impact of interest rates on various sectors

In the long term high interest rate would have a specific impact. The sectors which are impacted by high interest rate are the real estate, automobile and all the financial industries. However one sector that tends to benefit most is the financial industry. Banks, brokers, mortgage companies and insurance companies increases their earnings due to higher interest rates since they can charge more for lending. Thus any investment done in these sectors must be taken with consideration during the situation of high interest rates. High interest rates can increase costs for companies due to various activities. The increased costs can result in lower profits and subsequently lower stock prices. However, gradually rising interest rates might be beneficial for the stock market, as it may reflect positive trends in the underlying economy.

Sectors least affected by change in interest rates

The IT sector is more influenced by factors such as currency rate fluctuations. Overall the IT sector is not interest rate-sensitive. Pharma is considered as defensive sector and investors can invest during uncertain and volatile market conditions as well. Thus there is no major change in the stock of these companies due to change in the interest rate.

India as a country needs balance between high and low interest rates. Interest rates cannot be too high and it cannot be very low. A moderate inflation & interest rate over a period of time helps the banks, business community and the stock market to perform well.






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