The Bank of England committee decided to increase the base rate from 5% to 5.25% at their meeting today. This marks the 14th consecutive rate hike in the UK, which is really quite something. The committee also noted that rates could head higher still, with a close eye being kept on inflation. Despite the FTSE 100 dropping on the news, here’s how I can still profit going forward.
The relationship between stocks and rates
Some might say that rising interest rates are bad for all companies in the FTSE 100. General business theory indicates that if rates are high, the cost of borrowing goes up. Given that most large-cap stocks have debt, it raises the cost of servicing and issuing new loans. As a result, this could negatively impact profits and cause the share price to fall.
Another element to consider is that consumers are put under more financial pressure with higher rates. This could mean they spend less, reducing demand for business goods and services.
This is true, but it doesn’t reflect the situation for all companies. A good way to gauge which firms aren’t that negatively impacted is to look at the stocks that are up today despite the overall index being down.
Banking stocks leading the way
Going through the index, I note the likes of Barclays and NatWest Group are in the black. This doesn’t surprise me massively, given the way that these high street banks make money. Traditionally, the bank lends to customers and pays on deposits. The difference in this rate is the net interest margin, the profit for the bank.
Higher interest rates make it easier for the banks to make a larger margin. After all, mortgage rates have soared (lending to customers) yet deposit rates haven’t increased that much.
So a way to profit from this can be to look to include banking stocks in a portfolio. As a risk, banks with a large retail division could be hampered by increasing loan defaults, driven by customers feeling the pinch.
Growth stocks brushing off negativity
Another section of the FTSE 100 to consider are growth stocks. For example, Rolls-Royce shares are up 3% thanks to stronger-than-expected financial results.
The stock is up 109% over the past year and doesn’t seem to be showing any signs of slowing down. The benefit of including stocks like this in a portfolio is that the momentum behind the company can outweigh the impact of interest rate movements.
Sure, Rolls-Royce holds several billion in debt. Yet the revenue growth and projected forecast going forward is likely going to easily offset the debt cost increase.
Granted, growth stocks do have higher volatility than others, but it can be a lucrative source of potential profits.
