It looks as if interest rates will rise again soon. Will this have any effect on the stock market?
It is looking increasingly likely that the Bank of England may increase interest rates next month. The Monetary Policy Committee will meet again in early November to decide whether the British economy is strong enough to sustain another base rate hike.
According to Reuters, there is an 80% chance that interest rates may rise in November. Significantly, almost one in four economists reckon that the cost of borrowing may climb further still to 5.25% in the first three months of next year. But does this really matter to us as investors?
It seems that some people reacted badly to the last rate rise on 3 August -- admittedly the hike was a bolt from the blue. The FTSE lost almost 100 points or 1.5% on the day when the Bank of England wrong-footed speculators with a quarter point hike to 4.75%. Naturally, shares in rate-sensitive companies were some of the worst hit. Countrywide
(LSE: CWD)
, which owns the UK's largest chain of estate agents, tumbled 8%, and property website Rightmove
(LSE: RMV)
fell 6%.
Other companies that were caught up in the sell-off included popular housebuilders. Persimmon
(LSE: PSN)
fell 4%, Barratt Development
(LSE: BDEV)
retreated 5%, and Wimpey
(LSE: WMPY)
receded 5%. Banks, which are also reckoned to be sensitive to the cost of borrowing, lost ground, too. HSBC
(LSE: HSBA)
stumbled 2%, HBOS
(LSE: HBOS)
reversed 3%, and Lloyds TSB
(LSE: LLOY)
softened 2%.
Interestingly, the sell-off after the interest rate hike was quite short lived. It took less than four weeks for the FTSE to recover its pre-hike level of 5,932 and it has since moved another 4% higher. The table below lists some of the worst affected shares on the day that the Bank of England raised rates, and their prices now.
| Company | Price on
3/08/06 | Price
today | Change |
|---|
| Countrywide | 387p | 514p | +33% |
| Rightmove | 270p | 345p | +28% |
| Persimmon | 1,242p | 1,330p | +7% |
| Barratt Developments | 945p | 1,082p | +14% |
| Wimpey | 466p | 515p | +11% |
| HSBC | 956p | 1,000p | +5% |
| HBOS | 959 | 1,089p | +14% |
| Lloyds TSB | 518p | 560p | +8% |
It looks like shares that were caught up in the sell off have more than recovered. This raises an interesting questions about the effect of interest rates on the stock market. They can have both positive and negative effects.
For example, when interest rates increase companies may decide to cut back on investment and, in time, this can lead to lower profits. On the other hand, higher interest rates are used to contain a strong economy, and a strong economy is obviously favourable for company profits.
So do interest rates really matter to stock market investors? In my view, not a great deal. That is unless you allow them to prey on your mind. Picking strong companies on attractive valuations is much more fruitful than worrying about short-term economic factors.
