How do interest rate cuts affect investors?

On August 1st, the Bank of England lowered interest rates for the first time in four years.

The new interest rate is 5%, down from the previous rate of 5.25%, which had been set in August 2023 after 14 consecutive hikes.

But how might this rate reduction impact your investments? Keep reading to explore the connection between interest rates and your portfolio, and what this shift could mean for you.

WHY ARE INTEREST RATES IMPORTANT?

Interest rates essentially reflect the cost of borrowing money and can impact both economic activity and the value of certain investments. They also provide a helpful indication of the economy’s overall health.

Interest rate increases or decreases are often anticipated in advance, meaning they’re typically already accounted for in investment prices. Therefore, shifts in expectations about future interest rates tend to have a stronger influence. In global investment portfolios, UK interest rate expectations play a crucial role, especially for investors with portfolios focused on the UK market.

HOW DO INTEREST RATES IMPACT BONDS?

Bonds are essentially loans issued by governments or companies. They usually provide a fixed interest payment and return the initial investment when the bond reaches maturity.

Bonds generally perform better when interest rates fall. As rates decrease, the interest, or “yield,” on existing bonds becomes more attractive compared to the lower yields offered by new bonds, which can increase the price of existing bonds.

On the other hand, when interest rates rise, investors often seek higher returns on bonds. Since bond interest is fixed, the only way for yields to increase is for bond prices to decrease. This is because bond prices and yields are inversely related – when bond prices decrease, yields rise, and when prices increase, yields fall.

HOW DO INTEREST RATES IMPACT SHARES?

Shares aren’t directly influenced by changes in interest rates, but they can still be impacted. Generally, falling interest rates can be favourable for shares. Lower rates reduce borrowing costs for companies, potentially spurring growth and increasing earnings. Additionally, if mortgage rates decrease, consumers may spend more, which can benefit the businesses from which they purchase goods and services.

Conversely, in a high interest-rate environment, borrowing becomes more expensive. This can lead companies to limit their spending and investments, while consumers may cut back on their expenditures, potentially reducing sales for businesses.

Interest rate changes affect different sectors in varying ways. For instance, if interest rates are anticipated to drop, the technology sector might benefit. Investors are often attracted to tech companies due to the potential for higher future earnings, which become more appealing when lower interest rates make other investments like cash and bonds less attractive.

On the other hand, banks may benefit from higher interest rates since they can earn more from the difference between the interest they charge on loans and the interest they pay on deposits.

In practice, the impact of interest rate changes on different sectors can be complex and unpredictable. This is one reason why maintaining a diversified portfolio across various sectors is important.

ARE INTEREST RATE CUTS ALWAYS BENEFICIAL?

Rate cuts might seem like good news and rate hikes like bad news, but it’s not always that simple.

The reasons behind a rate change often matter more than the change itself. For example, the rate cut on August 1 was due to better news about inflation. But in the past, rate cuts happened during big crises like the global financial meltdown and the COVID-19 pandemic, when the economy was struggling badly. Back then, rates were slashed to historic lows to help boost the economy.

WHAT DOES THIS MEAN FOR YOUR PORTFOLIO?

Interest rates will fluctuate over time, rising and falling in cycles. Making investment decisions based solely on interest rates is not advisable, as they are only one factor affecting investment performance.

Attempting to adjust your investments in response to changes in interest rate expectations can be risky. Even seasoned investors find it challenging to time the market effectively, which could lead to missing out on potential gains or locking in losses, potentially hindering your long-term investment success.

It’s generally wiser to ignore short-term fluctuations and focus on maintaining a well-balanced portfolio. This means having an appropriate mix of stocks and bonds, and diversifying your investments across various regions and sectors. By adhering to your investment strategy and keeping a long-term perspective, you’ll be better positioned to achieve your financial goals.

GET IN TOUCH

If you’d like support in navigating the interest rate fluctuations, please do get in touch with us at Rosebridge.

Ramsbottom office: Email enquiries@rosebridgeltd.com or call 01204 300010

Chester office: Email enquirieschester@rosebridgeltd.com or call 01244 569141

Leeds office: Email enquiriesleeds@rosebridgeltd.com or call 0113 243 7100

PLEASE NOTE

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

Please do not act based on anything you might read in this article. If you require personalised advice, please contact your financial adviser

All contents are based on our understanding of HMRC legislation and regulations, which are subject to change.

The value of investments and any income from them may go down. You may not get back the original amount invested. Past performance is not a reliable indicator of future results