Why rising interest rates could cause a crash

Rising inflation means that interest rates are going to be raised later this year. Charles Archer considers why this makes blue chip stocks more attractive for his portfolio.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Inflation in newspapers

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Inflation is rising, and interest rates are likely to follow. That’s because unlike other political problems, there’s only one solution to high inflation — making borrowing more expensive. But this could cause a crash. Here’s why.

Multiple inflationary factors

The labour shortage is causing wages to rise, while the supply chain crisis is simultaneously causing supply to fall. Raw material price increases are now hitting basic goods like food. Kraft Heinz CEO Miguel Patricio said yesterday that inflation was “across the board“, and that, “we are raising prices, where necessary, around the world“. As economies have restarted, production has not been able to keep up with increased demand.

The ongoing petrol shortage is a good example of inflation in action. There’s far higher demand than during the pandemic, but not enough petrol being delivered to cope. This has led to petrol prices increasing. Oil prices are also now at historic highs, and these price increases will soon feed back to consumer goods. The gas shortage has sent multiple smaller suppliers to the wall. Meanwhile, the largest energy suppliers are now losing money from the gas they’re selling. When the price cap rises again in April, so will everybody’s bills. Far from being transitory, it appears to me that inflation is here to stay. 

Passive income stocks: our picks

Do you like the idea of dividend income?

The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?

If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…

Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.

What’s more, today we’re giving away one of these stock picks, absolutely free!

Get your free passive income stock pick

Inflation and interest rates explained

The Bank of England’s annual inflation target is 2%. That means that a product that costs £1 now will cost £1.02 a year from now. This incentivises consumers to spend money, which helps to grow GDP. If inflation falls below this target, demand falls as well, because the incentive to spend is removed. If it rises too high, disposable income becomes less valuable, so consumers buy less. 

This is how I see the relationship between inflation and interest rates:

  Low inflation High inflation
Low growth Lower interest rates Danger Zone
High growth Do nothing Raise interest rates

The UK is currently in the danger zone. With low growth and high inflation, there’s only two possible scenarios going forward. Either the BoE raises interest rates, which could permanently damage our economic recovery by slowing growth. Or, it lets inflation continue to rise, allowing a cost of living crisis to unfold. 

The high debt trap

Bank of England MPC member Michael Saunders said yesterday that “markets have priced in over the last few months an earlier rise in Bank rate than previously…I think it is appropriate that the markets have moved to pricing a significantly earlier path of tightening than they did previously”. I think this means that interest rates are likely to rise very soon.

This would increase the cost of business debt accumulated during the pandemic. It would also increase the interest due on the UK’s £2trn national debt. For individuals, there will be more interest due on mortgages, credit cards, and loans. Combined with a national insurance rise, council tax rise, and frozen income tax bands, I think next year could see a massive fall in disposable income. This would hit spending hard.

Any company with high debt levels is in danger. It’ll soon be paying higher interest, while also coping with falling consumer demand. Going forward, I’m sticking to blue chip companies with low debt and a proven business model. 

5 Shares for the Future of Energy

Investors who don’t own energy shares need to see this now.

Because Mark Rogers — The Motley Fool UK’s Director of Investing — sees 2 key reasons why energy is set to soar.

While sanctions slam Russian supplies, nations are also racing to achieve net zero emissions, he says. Mark believes 5 companies in particular are poised for spectacular profits.

Open this new report5 Shares for the Future of Energy — and discover:

  • Britain’s Energy Fort Knox, now controlling 30% of UK energy storage
  • How to potentially get paid by the weather
  • Electric Vehicles’ secret backdoor opportunity
  • One dead simple stock for the new nuclear boom

Click the button below to find out how you can get your hands on the full report now, and as a thank you for your interest, we’ll send you one of the five picks — absolutely free!

Grab your FREE Energy recommendation now

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Charles Archer has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Bus waiting in front of the London Stock Exchange on a sunny day.
Investing Articles

Here’s how £300 could set a stock market beginner on the path to riches in 2025!

Christopher Ruane digs into some practical details to explain how someone could start investing in the stock market with just…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

Can Nvidia stock really merit its current valuation?

Nvidia stock has been on a tear, to put it mildly. This writer thinks that can be justified -- and…

Read more »

Investing Articles

Could Rolls-Royce shares halve in value this year – or double?

After another incredible 12 months for Rolls-Royce shares, Christopher Ruane considers whether the coming year could be even better --…

Read more »

The flag of the United States of America flying in front of the Capitol building
Investing Articles

2 FTSE 250 shares that could soar while Donald Trump is US President

Ben McPoland thinks these FTSE 250 shares look well-positioned to benefit under a Trump administration due to tax cuts and…

Read more »

Market Movers

Why the Netflix share price surged 14% after the market closed

Jon Smith runs over why the Netflix share price has rocketed higher and explains why he's optimistic about the direction…

Read more »

Investing Articles

£20,000 in an ISA? Here’s how an investor could target £550 of passive income a month

This writer shows how a respectable passive income stream can accumulate from pretty modest beginnings inside a Stocks and Shares…

Read more »

Investing Articles

Here’s the dividend forecast for Lloyds shares for 2025 and 2026!

The dividend yield on Lloyds shares continues to comfortably beat the FTSE 100 average. But are future payouts in jeopardy?

Read more »

Dividend Shares

£287 a week? Here’s how an investor could use an ISA to build alternate income

Jon Smith outlines both the value in using an ISA for investing and also how a tidy second income can…

Read more »