We hear about interest rates almost daily in the media, with reports about property, business as well as the share market. Understanding what interest rates are, and how they affect the share market will give you more confidence as an investor.
On the first Tuesday of every month, the Reserve Bank of Australia (RBA) sets an official cash rate, which is the rate used on loans for commercial banks. An interest rate is the cost associated with borrowing someone else’s money; credit cards, mortgages, car loans, business loans.
The RBA decides each month if interest rates are to stay the same, or whether they need to be raised or lowered (and by how much of a percentage). When our economy’s conditions are low, more often than not a low cash rate is set. When the conditions are better, the cash rate is generally raised with the intention of slowing down these conditions. Investors and experts try to predict the official cash rate decision, which can in turn affect the buying and selling activity in the share market.
Below is a summary of the three potential outcomes for interest rates each month:
If interest rates remain unchanged
- This often means that the Federal Reserve believes the economy is performing below average, and a rise in interest rates would affect further growth
If interest rates go up
- It becomes more expensive for banks to borrow money from the Federal Reserve
- For investors, this means that banks will often pass on the higher rate to their customers who borrow money, which can be a big deal for your hip pocket
- Stocks are affected indirectly, because this higher interest rate means that companies are likely to borrow less money, which leads to slower business and decreased profit
If interest rates go down
- When the rates are lowered, share prices may increase – which can be great news for investors
- Companies with large debt will be better off, as their interest payments will be reduced and their revenue can directly evolve into higher earnings
As investors, we cannot control the way in which rates fluctuate, so it is best to not let it greatly influence the way we buy and sell shares. Furthermore, the sentiment as to how investors think the RBA might act is factored into market price action before a rate decision is made.
The good news for investors is that you can utilise investment software that helps take all the guesswork out of investing with fully researched processes that tell you what, when and how to buy and sell. Contact Share Wealth Systems to find out how.
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