Today (18 September) sees the central bank meeting for the US Federal Reserve. The committee is widely expect to cut interest rates. Tomorrow is the turn of the Bank of England. Although I don’t expect the decision-makers to reduce the UK base rate now, I do think we’ll get at least one more cut before the end of the year. Here are some UK shares that I think could benefit the most.
Understanding the economics
Let’s first quickly recap why lower interest rates helps stocks in general. When the interest rate is low, people have more of an incentive to spend rather than save. As a result, it generally helps to stimulate growth in an economy.
Further, funding and debt is cheaper, as the rate to borrow is lower. This means that businesses can help to grow faster by taking on more debt. If a business took on debt at a higher rate, it can also look to refinance this at a lower rate, easing the interest payments.
Even though cuts to the base rate should benefit the stock market in general, there are some specific areas that should outperform. Typically, these are the sectors that are most sensitive to interest rate movements.
An idea that I like
A homebuilder like Taylor Wimpey (LSE:TW) is a good example of a stock I have on my watchlist. The share price is already up 40% over the past year, in part due to the positive sentiment returning to property as investors expect rates to fall.
The firm should benefit as mortgages become even more affordable. This should boost sales, with rising house prices also helping to increase revenue. I believe Taylor Wimpey is well positioned for this. In the latest financial report, the CEO noted that “we expect to deliver 2024 full-year UK completions towards the upper end of our previous guidance range of 9,500 to 10,000”. This means that there will be plenty of opportunity for the company to benefit from higher demand.
A risk is that inflation pressures persist. Even though the headline level of inflation has been falling, the business has flagged up the negative impact of residual build cost inflation. This eats into profit margins, which isn’t great.
Finance in focus
Another area that I’m looking at is banking. This might sound odd, as FTSE 100 firms like Lloyds Banking Group and NatWest Group have large retail client bases that hold a lot on deposit. So if interest rates fall, shouldn’t the net interest margin shrink, lowering revenue?
Although this is true, I think it could be offset by the rise in demand elsewhere, such as mortgages. Yet even with general card spend and more interest in personal loans, I think the retail-focused banks could see revenue spike in many other areas.
As a result, I’ll be monitoring the upcoming trading updates closely to try and get a feel for how these divisions are performing. Along with Taylor Wimpey, if I see these stocks doing well in the coming month, I’m going to seriously consider adding them to my portfolio.
