How interest rates affect stock markets

Banks are the biggest companies in the world everybody is connected to the bank in a way.
They are so big that the whole economy of the country is dependent on it as well as the stock markets.

The banks earn money on interest rates, they lend money to borrowers and the borrower repays them with the fixed interest rate.
The banks use our money to lend to their customers and we get fixed interest rates in return by just depositing the money.
But the question arises how interest rates affect the stock market?
Well everybody knows that companies need to borrow money in order to expand their companies growth.
So because of low-interest rates, they will borrow money easily because they have to return low interest on it.
On the other hand, if there is a hike in interest rates then companies will have to give more interest on the borrowed money which will ultimately reduce their profits.

So if the interest rates go lower there is an increase in stock prices and if the interest rates go higher there is a decrease in stock prices.
Because of high-interest rates the big investors FIIs and DIIs will move their money from stock markets to debt funds.
As you all know the simple and most risk-free investment is fixed deposits. If you to invest money in any instrument you will surely compare that with fixed deposits.
When the price of interest rate goes higher then the fixed deposits become more lucrative and people will want to move towards fixed deposits because they are getting their returns higher without any risk.
So this will lead to decrease in liquidity in stock markets which are not good.
“The more the merrier” if the people are investing more in stock markets it will be healthy for stock markets.

Let me tell you one example, if I am expecting 10% return on my investment in stock markets while I am getting 7% return on it because of low-interest rates, I will surely invest in stock markets because I am getting higher return but on the other hand if the rates of interest go higher then the interest rate of fixed deposit also goes higher then I am getting 10% return in fixed deposits as well as in stock markets I want to ask you which will you prefer if you are getting 10% on both the instruments? You will definitely prefer fixed deposits because they are giving you an equal amount of return on your investment as compared to stock markets with no risk.
So you will move your money into fixed deposits which will reduce the liquidity of stock markets.

But then you want to ask if the interest rates are not healthy for stock market then why banks increase the interest rates?
Well, the answer is they have to do it in order to control the inflation and because of increase in Bond yields.

So the conclusion is an increase in interest rates is bad news for stock markets and the overall economy.

Banks are one of the biggest buyers of bonds, if the interest rate is going up then the banks will buy bonds because of interest rates hike.

As banks provide most of the liquidity in the stock markets, it would not be able to do it because they are moving their money in the bonds.

Read: Why interest rates go up and down

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Saifullah Khan

Hi there, I am the owner of gloomyworld.com, read more about me here.

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