When the Federal Reserve and central banks around the world lower interest rates, investors need to be aware of the potential impact of such a decision. The relationship between the stock market and interest rates aren’t straight forward. But for the most part, they move in opposite directions.
Governments cut interest rates to stimulate the economy. It will encourage people to borrow more and businesses can expand at a lower rate. At the same time, this means that those lending the money or buying securities have a diminished opportunity to make money from interest.
As a result, this can make investors move their money to the equity market from the bond market. As businesses borrow and expand, their future earnings will also have the potential to rise. So stock prices will also increase at the same time.
Governments task central banks with keeping the country’s financial system fairly stable. As a result, they have the power to make charges to broad monetary policies that affect the government’s fiscal policy.
They also manage and oversee the production and distribution of currency, promote economic growth, lower unemployment, and share statistics with the public, and implement changes to the discount rate. Any investing for beginners course will tell you that the power to decrease or increase the discount rate has the most influence on the building blocks of macroeconomics.
Depository institutions and banks get short-term loans from their local central banks at an interest rate known as the discount rate. So if you break it down to the basics, the discount rate can be understood as the cost of borrowing from a nation’s central bank.
So when there’s a change to the discount rate, economic activity within the country will either rise or fall (depending on the expected outcome). Central banks usually decrease the discount rate when the local economy is stagnant or slow.
When you make borrowing more affordable for banks, the effects of it can be felt throughout the nation. Savings will be passed down to customers through lower interest rates which in turn leads to more borrowing and spending while rates are low.At the same time, there can be a reduction of interest rates on savings vehicles like money market savings accounts and certificates of deposit (CID). So whenever there’s an announcement of countries lowering interest rates, you can expect a lot of economic activity.