How do interest rates affect the stock market

What are interest rates and why do they matter for stocks?

Interest rates are the cost of borrowing money and the benchmark rate used in valuations. Central banks adjust policy rates to manage inflation and support growth and jobs.

• When rates rise, borrowing gets more expensive. Higher discount rates reduce the value of future cash flows, weighing on profits and share prices.
• When rates fall, cheaper borrowing can boost liquidity and support equities.

Shifts in rates also affect sentiment: cuts often encourage risk-taking, while hikes can push investors towards bonds.

How central banks set interest rates

Interest rates are shaped by each central bank’s mandate, data on inflation and growth, and the signals they give to markets about future policy.

Monetary policy framework

Central banks operate under different mandates when setting rates. The US Federal Reserve balances inflation with employment. The European Central Bank (ECB) and the Bank of England (BoE) focus mainly on price stability. All track inflation, wage growth and output gaps to set their stance.

Rate-setting meetings

Policy committees – such as the Fed’s Federal Open Market Committee (FOMC), the ECB’s Governing Council and the BoE’s Monetary Policy Committee (MPC) – hold scheduled meetings that end with rate decisions. These announcements are usually followed by press conferences and updated economic forecasts.

Forward guidance

Central banks often move markets without changing rates. The Fed uses “dot plots” to show policymakers’ future rate expectations, while the ECB and BoE guide investors with forecasts, meeting minutes and speeches. This communication helps reduce uncertainty.

How do interest rates affect stock prices?

Interest rates influence stock prices through several channels – shaping borrowing costs, consumer behaviour, currencies and overall market sentiment. These effects often extend to CFD stock prices, as underlying market valuations adjust to changing rate conditions.

• Cost of capital – higher rates mean higher interest expenses for companies, reducing free cash flow and profit margins. Firms with significant debt tend to be most affected, often leading to lower valuations.

• Discount rate effect – share prices are based on the present value of future cash flows. The discount rate combines the risk-free rate and an equity risk premium. When policy rates rise, both typically increase, which lowers valuations. Growth-oriented firms, whose earnings are expected further in the future, are usually more sensitive.

• Consumer spending – when mortgage and loan costs rise, households may cut back on discretionary spending. This can weigh on sectors such as retail, housing, and leisure, where demand depends on consumer confidence.

• Currency strength – higher domestic rates can attract foreign capital, lifting the local currency. A stronger currency can make exports less competitive and reduce overseas earnings once converted back.

• Risk premium adjustment – as rates increase, investors may require a higher equity risk premium – a larger expected return for holding shares instead of bonds. This can lead to broad market repricing and stronger correlations across asset classes.

Historical examples: Rate hikes and market reactions

Looking back at past cycles shows how interest-rate decisions, combined with the wider economic backdrop, can shape equity returns.

Past performance is not a reliable indicator of future results.

The pace and size of policy changes matter. The rapid hikes in 2022, against persistent inflation, led to sharper drawdowns than the slower, more gradual cycle of 2015–18. By contrast, the aggressive cuts of 2020 – made during the pandemic – contributed to a rebound in equities.

Impact on key equity sectors

Interest rate shifts change borrowing costs, spending and valuations – with different effects across sectors.

Financials

Banks and lenders benefit from wider margins when short-term rates rise. But rapid tightening can raise funding costs, and downturns increase loan defaults. An inverted yield curve may also squeeze profits.

Technology

Higher discount rates weigh on valuations. Extended tightening can delay investment in new software or hardware. Still, firms with subscription-based models may prove steadier if revenues hold up.

Consumer discretionary

Spending on non-essentials is highly sensitive to credit costs and household income. Luxury items and large purchases are usually the first to suffer when borrowing becomes expensive.

Utilities and real estate

Often underperform when bond yields look more attractive. REITs are particularly exposed, as their dividends must compete directly with fixed income returns.

Industrials

Rising financing costs make it harder to fund large projects. However, state-backed infrastructure programmes – driven by fiscal policy rather than rates – can offset some of the pressure.

Managing risk in rate-driven environments

From sudden repricing to shifting yield curves, rate changes can create risks that traders can manage with the right tools and strategies.

• Position sizing – adjust exposure to match current market volatility, especially in interest-rate futures and bond ETFs. This helps balance risk and reward across asset classes.

• Hedging – protects against sudden market moves with puts on broad indices. If direct options aren’t available, traders may use CFD proxies or structured products instead.

• Diversification – balance equity exposure with bonds and gold CFDs. Gold often acts as a hedge when real (inflation-adjusted) rates fall, making non-yielding assets more attractive.

• Stress testing – run simulations of rate shocks, yield curve shifts or duration changes. Practice in a demo account to simulate trading strategies in a risk-free environment.

Explore our risk management tools on our risk management page.

Trading strategies around rate changes

Traders can adapt their strategies to interest-rate moves, using approaches that range from short-term reactions to long-term positioning.

• Day trading: focuses on short bursts of volatility around central bank announcements or data releases. CFDs with tight stop-losses are often used to capture intraday moves from unexpected policy news.*

• Swing trading: looks to profit from rate-driven swings lasting days to weeks. This can mean rotating into sectors likely to benefit after a policy change, or shorting those expected to lag.

• Trend trading: aligns positions with the overall market direction that develops after a series of rate moves. For example, sustained tightening cycles often favour defensive stocks, while prolonged easing can support growth and cyclical shares.

• Position trading: takes a long-term view, holding for months to capture the impact of extended policy cycles. Traders often track yield curves and sector performance to stay positioned through different phases of monetary policy.

*CFDs are traded on margin, leverage amplifies both profits and losses. Stop-loss orders are not guaranteed, while guaranteed stop-loss orders incur a fee if activated.

Explore more approaches on our CFD trading strategies page.

Global perspective on rate regimes

Global interest rate policies vary by region, influencing currencies, capital flows, and sector performance in different ways.

Different monetary policies shape currency flows and sector performance across regions.

• United States: higher rates before recent cuts drew global capital into US markets, strengthening the dollar.
• Eurozone: stalled rates mean less movement, leaving European equities at risk of outflows.
• UK: a wait-and-see stance keeps markets sensitive to incoming data.
• Japan: negative rates and yield-curve control continue to support exporters, with the weaker yen boosting overseas sales.

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