How low central bank rates boost equities

We’re living in a new era of very low central bank rates, so we’d do well to understand how they help boost equities! At face value it’s pretty simple: the central bank lowers interest rates which encourages people and businesses to put money to work in the economy, since they get very little when they put it to bed at the bank. People who have tracker mortgages that are linked to interest rates see their monthly repayments go down a bit, which gives them a bit more disposable income and thus raises their sentiment levels.

Low rates can also encourage people to take out mortgages in the first place, buoying the housing market which in turn helps shares in companies that build houses as well as those that produce building materials. A combination of businesses borrowing to create jobs and grow, and people having a bit more cash to spend should spur economic growth, and when that’s happening, equities in the consumer staples and retail sectors benefit.

However there are other, less direct effects of low central bank rates that are just as important. Low interest rates serve to weaken a country’s currency and give just as valid a reason for equities going up. For example, with a much weaker GBP versus the USD, many UK listed companies that do most of their business in Dollars have benefitted handsomely since a) the Brexit vote and b) the Bank of England rate cut on Thursday 4 August. Thus, investors looking for capital gains have been buying what would normally be considered defensive equities – those whose stocks do not move around a lot but do pay decent dividends.

The latter is perhaps the most interesting effect of low central bank rates because it’s novel and fairly unprecedented. We’re now in a situation whereby the US Fed wants to raise US bank rates, while the Bank of England has said it will cut UK bank rates more if need be. This divergence in monetary policy has widened the chasm between the US Dollar and British Pound, and it’s not set to ease any time soon. So when you’re considering which equities you’re going to invest in next, you may want to consider something you might not have thought about before.

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Have a great weekend!

Augustin Eden, Research Analyst