Bank of England policy chiefs on Thursday (14 December) chose to hold UK interest rates at 5.25%. This move signals potentially happier times ahead for stock market investors — and I’ll explain exactly why.
British interest rates remain at 14-year highs. But signs from the Bank’s opposite number in America suggest rate cuts will come quickly in 2024.
Over the last two years the Bank of England has aggressively hiked rates. This has added to the amount companies must pay on their debt and has dampened valuations across the FTSE 100 and FTSE 250.
At the same time, soaring inflation and a higher interest rate environment have meant the average investor has been forced to spend more on necessities.
These include groceries, petrol, credit card debt, as well as higher mortgage payments. Household savings have fallen dramatically, while investors have had to contend with having less disposable income.
What America did
The Federal Reserve — also known as the Fed — sets interest rates in the US. This week its economists put out forecasts suggesting it will drop its benchmark rate in 2024.
The Dow Jones, one of the country’s largest stock market indexes, reacted quickly. The index of 30 major companies, which includes Apple, Boeing, Microsoft and Coca-Cola, jumped 500 points to close above 37,000, a record high.
Again, when central bank key interest rates fall, so do borrowing costs. Markets tend to see this as a catalyst for higher share prices across the board.
So, both the Bank of England and the Federal Reserve decided to hold interest rates at November’s level If the cost of debt falls next year, stock markets should shift higher in response.
Stock market pain
UK interest rates sat at 0.1% in December 2021. Back then, it was extremely cheap for companies to borrow to fuel expansion plans. But the near-zero environment came to an end as policymakers rushed to tame soaring inflation.
The resulting situation forced analysts and brokers to cut price targets for debt-laden businesses.
Investment bank Goldman Sachs now says UK interest rates will drop sharply to 3.75% by the end of 2024.
With signs that decades-high interest rates could be coming to an end, it means relatively riskier plays and companies with higher debt burdens could see their values spike.
But aren’t we in a recession?
It’s worth reiterating that the stock market is not the economy. Both UK and global growth are forecast to be sluggish for at least the next two years.
The Institute for Fiscal Studies expects companies to face weak profit margins in the first half of next year. It says UK GDP will fall to -0.7% in 2024.
And inflation remains unnervingly sticky. Prices for consumer goods are still rising, albeit at a slower rate than before.
But after such a painful high-rate period, the slightest hint that we have reached a pivot should boost stock market sentiment.
One of the most useful things we as investors can do to improve our wealth is to learn to understand the broader economy. And one of the key lessons is how interest rates could affect portfolio company valuations.
This impacts everything from how much we should invest, and how much our SIPPs or other investments may be worth when we retire.
