8 implications of higher interest rates for the stock market

Yesterday, the Bank of England increased the interest rate by 0.5%. This is the sixth consecutive hike from the central bank, taking the base rate to 1.75%. As an investor, the jump in the rate is good in some ways and bad in others. Here’s what I think it could mean for stocks.

1. Pressure on debt-laden companies

Listed firms that carry a lot of debt on the balance sheet will find it harder. Higher interest rates mean that when new bonds are issued, a higher rate needs to be offered, in line with the going market. Investors will be aware of this, meaning that the share price could be under pressure. Higher interest costs also eat into the profitability of a company.

2. High interest rates for banking stocks

Traditionally, banks gain during a rate hike cycle. This is because it allows for a larger margin to be built in on the rate charged on loans and the rate offered on deposits. This is known as the net interest margin. The higher this margin is, the more profitable the bank is.

3. Travel and tourism could struggle

Consumers tend to save rather than spend due to the rate being lifted. As a result, this could hurt stocks that are on the front line, namely travel and tourism businesses. If people cut back on luxuries and discretionary spending, it’s this sector that could be hit the hardest.

4. Uncertain outlook for property stocks

Mortgage rates have already moved higher, and could continue to do so. This could make people reconsider the prospect of buying a house. Some existing homeowners could default on payments. On the other hand, property prices have remained incredibly resilient so far this year and could continue to do so. Whichever scenario turns out to be correct, it’s a very uncertain time for stocks related to property.

5. Easing inflation-linked struggles…

One factor that has been noted in a lot of Q2 earnings reports is the inflation problem. In theory, raising interest rates should help to dampen inflation and bring it back to the 2% target. Therefore, once this starts to take effect, falling inflation should help profit margins recover in general.

6. …but stunted economic growth

The flipside of clamping down on inflation is that economic growth is hurt. The latest forecast from the Bank of England highlights the potential for a recession at the end of the year. For firms that are globally-focused, this should have limited impact. But for mainly domestic businesses, this would be a big negative.

7. Uncertain investor sentiment

The FTSE 100 in general could struggle to see a meaningful rally, therefore staying in a range such as we’ve seen so far in 2022. Higher rates could cause investors to be more picky about what to buy. If the base rate hits 2.5%-3% by the end of the year, there’s a big opportunity cost to weigh up. Should I earn guaranteed interest on a deposit account, or aim to outperform via stocks?

8. Money managers should do well

Given the uncertainty ahead, I think fund managers and listed investment trusts could do well. Handing a portion of my money over to the professionals could help me to navigate choppy waters going forward.

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