Interest rates and their impact on the economy and in turn, the Stock Market
The Monetary Policy Committee (MPC) of the Reserve Bank of SA announced a 1 % cut in interest rates = to 100 basis points. The repo rate has therefore moved from 6.25% to 5.25%. One basis point is equal to one one-hundredth of one percentage point (0.01%). Therefore, 100 basis points would be equivalent to 1%.
The MPC has also announced that there is the possibility of a further 2 cuts in interest rates, resulting in a cut of a further 50 basis points (25 basis points (0.25%) each).
What does this mean?
Interest rates are one of the most important aspects of any Country’s economic system. It influences the cost of borrowing, the return on savings, and is an important component of the total return on many investments. Refer to the article on News24: https://www.fin24.com/Economy/South-Africa/sas-big-rate-cut-is-a-plaster-on-a-gaping-wound-20200320
How do interest rates affect the economy?
The rate of interest that is offered by financial institutions affects consumer decisions on whether to save or spend their money. Usually, when interest rates are high, people tend to save or deposit more of their money into Money Markets. When interest rates increase, people tend to borrow less, since it costs more to take out loans today and means lower spending in the future by consumers. Businesses operate the same way, higher interest rates increase the cost of doing business.
If interest rates are lower, banks are able to lend money for less. They are able to lower the interest rates they charge individual borrowers, making their loans more attractive and competitive. If an individual was thinking about buying a home or a car, and the interest rates suddenly go down, the consumer might decide to take out a loan and spend more in the retail sector instead. The more consumers spend, the more the economy grows. That is why the stock market tends to go up when interest rates are decreased or there is just a hint at lowering interest rates. It’s a sign to investors that people will be buying more goods and services and that companies will ramp up production and create more jobs.
When it comes to the stock market, lower rates make other investments less attractive. Investors in the Money Market will get less growth percentage on their investments that will cause short falls and force them to withdraw funds to go into the stock market. This will push stock prices up – another indicator of a healthy economy.
Which sectors are mostly affected by interest rates?
Commodity prices may fall when interest rates rise, suggesting that an interest rate hike may create an unfavourable climate for these investments and vice versa.
For Real estate, an interest rate hike can be detrimental, while a cut can be beneficial. The Property sector with high interest rates impact profits significantly. Therefore, low interest rates are a positive for this sector as debt becomes cheaper. The financial sector has historically been one of the most sensitive sectors to changes in interest rates. With profit margins that actually expand as rates climb, entities like banks, insurance companies, brokerage firms, and money managers generally benefit from higher interest rates.
Industrials, consumer names, and retailers can also outperform when the economy improves and interest rates increase.
Manufacturers in cars, clothes, hotels, restaurants, and movies also benefit from the lower and higher interest rates changes from the Monetary policy committee worldwide.
Healthcare stocks perform well in low interest rate environments as they are seen as stable assets. Technology stocks usually benefit when interest rates are rising as it is reflection that the economy is stronger. Therefore, low interest rates are a negative for this sector as these companies put a hold on expanding their businesses.
The communication services sector benefits from low rates as it is a service which consumers use in all different economic conditions. It is a defensive sector so does well in economically, fragile times.
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