How do interest rates affect the stock market?

Interest rates and the stock market aren’t directly connected. But increases or decreases in interest rates can have a noticeable effect on stocks, and not necessarily in ways you might expect. Here’s what you need to know.

What are interest rates?

Interest rates are an amount that borrowers are charged by banks and other financial institutions on the money they borrow, or savers are paid on the money they save, typically expressed as a percentage of the amount borrowed or saved.

Banks and financial institutions choose the interest rates charged on loans and paid on deposits, but these rates are often heavily influenced by the nation’s central bank. This rate is the interest rate the central bank pays to commercial banks that hold money with it. In Canada, this is the Bank of Canada base rate (also known as the “Bank Rate”). In the US, for example, it’s a rate set by the Federal Reserve.

How is the Bank of Canada base rate set?

The Bank of Canada decides on Canada’s base rate. A team of financial experts reviews the rate regularly, discusses economic concerns and projections with industry stakeholders and various analysts, and decides what the base rate should be to achieve maximum economic growth and efficiency for Canada’s domestic economic marketplace. The state of a country’s economy, and in particular the level of inflation, can have a big impact on bank rate decisions.

When do interest rates change?

That depends on the specific interest rate you’re talking about.

The Bank of Canada’s Governing Council meets eight times a year to discuss and set Canada’s base rate. That’s roughly every six weeks. But that doesn’t necessarily mean that the base rate will change this often. In fact, the base rate can stay the same for years at a time. For example, the bank rate remained set at 0.25% for two years — between March 2020 and March 2022. There have also been long periods of static base rates in the past.

But, in times of economic turbulence, things can change much more frequently as the Bank of Canada attempts to stabilize the economy. During 2022 and 2023, inflation has been high in Canada, so the bank has made frequent base rate hikes in an attempt to bring inflation back down to its target of 2.00%. As of April 12, 2023, the base rate was 4.75%.

Financial institutions that lend money or hold deposits can independently set and change interest rates at any time. However, in order to be competitive and attract customers (as well as to cover costs), the rates are often heavily influenced by Bank of Canada base rate changes. So, we often see banks adjusting advertised interest rates shortly after a base rate change.

How do interest rates affect stocks?

There’s no direct link between interest rates and the value of stocks. A change in one won’t automatically trigger a change in the other. However, interest rate changes can potentially affect other factors, which can, in turn, influence the value of stocks. These factors include:

• A higher cost of borrowing for businesses if interest rates rise. Businesses that are reliant on low-cost loans to grow — particularly where the loan rates are not fixed and are therefore subject to increases in central bank rates — may underperform financially overall. This may result in stock prices falling for such companies.
• Consumers have less disposable income in a high-interest-rate environment due to the higher cost of borrowing. This can have an effect on the demand for non-essential goods and services and, therefore, the success (and stock value) of companies delivering those goods and services.
• The way in which stocks are valued. A stock’s current value indicates what investors think a company is worth and what they are willing to pay for it today based on anticipated future value. This is calculated using a process called discounting. It converts a future value into today’s value by dividing it by something called a discount rate. Without going into too much detail, higher interest rates mean higher discount rates. And this means the calculations suggest a lower future value. This is particularly important for growth stocks, typically in newer companies, purchased for having high anticipated future value.

Finder survey: How much (in Canadian dollars) do Canadians with different incomes typically have invested in stocks?

Do any stocks go up in value when interest rates go up?

If interest rates are increasing gradually and the economy is strong, the impact on stocks is likely to be minimal to non-existent. But the factors we’ve outlined above mean that stocks typically go down in value when interest rates go up more than you might expect in a strong, stable economy. It’s not always a direct correlation, though, depending on the specific stocks.

Stocks in suppliers of non-essential goods and services and/or growth stocks are more likely to be hit negatively when interest rates climb. Suppliers of essential goods and services are likely to weather any effects better. And, in fact, banks and other financial institutions may do quite well out of it, as higher interest rates allow for charging higher rates on loans without increasing savings rates.

Value stocks, which are stocks in well-established companies that pay stable dividends, may also be a less risky bet in a high-interest rate environment. These stocks are typically more stable and less reliant on loans to deliver as a business.

What happens to stocks when interest rates fall?

The inverse is also true just as rising interest rates can make stock values fall. Falling interest rates have the potential to cause stock values to rise. Though, as with the opposite, it depends on the specific stocks and what else is going on with the company and the market at the time.

Can rising interest rates hurt the stock market?

Potentially, yes, if the cumulative impact of rising interest rates causes a large number of companies to perform less well than expected. Or, indeed, if the appetite for investors in buying higher-risk growth stocks causes a large number to instead invest in lower-risk alternatives, such as bonds.

But not every stock will fall in value, and this may be enough to even things out. And, even if the stock market suffers a temporary setback, this doesn’t mean all is lost. Remember that investing is for the long term, and time and time again, markets have been proven to recover from short-term setbacks.

What affects stock value other than interest rates?

The value of stocks in a company, and in some cases, the stock market as a whole, can be subject to multiple influences that impact supply and demand. These can include (though are not limited to):

• Company news and announcements. This may be expected (a report confirming a significant loss or profit, for example) or unexpected (such as the death of the CEO).
• Economic factors. These include interest rate changes but also other factors in relation to a country’s economic or political situation – such as a change of government.
• Industry trends. If a sector overall is performing well, it’s likely to positively impact all companies that operate in that sector (and vice versa). Consider, for example, the boom in tech companies during the coronavirus pandemic.
• Natural disasters. These can disrupt businesses, limit access to supplies and potentially increase debt.
• A change in the number of shares available. This could be caused by a company releasing new shares or buying back stocks or by lots of investors selling their stocks at once. Stock prices tend to be higher when the supply of stocks is low, and lots of investors want to buy.

Bottom line

There are lots of factors that can affect the stock market and indeed your own investment portfolio. Interest rates are just one of them, and may not necessary have the impact that you might expect.

You shouldn’t change your investment strategy just because of concerns about rising or falling interest rates. Instead, take a measured approach that looks at the bigger picture and takes account of your long-term investment goals. If in doubt, seek professional financial advice before making any decisions that could affect your financial future.

Frequently asked questions

• What happens to stocks when interest rates rise?

  Typically, interest rates and stock values tend to move in opposite directions. When interest rates climb, stocks fall, and vice versa. However, it's not quite this black and white in practice, with different types of stock being affected in different ways and a wide range of other factors also having an impact.

• How do interest rates affect bonds?

  There's a strong correlation between bonds and interest rates. When interest rates rise, demand for bonds falls, so the price drops. However, bond issuers must try to appeal to buyers, so the bond returns (or yield) is likely to increase. The reverse typically happens when interest rates fall.

• What are the best savings accounts interest rates in Canada?

  Canadian banks typically pay 1.5% or less interest on savings account deposits. Online banks and alternative financial institutions typically offer higher returns — often 2% or more — on your savings, not to mention lower fees. Check out our guide on the best high-interest savings accounts in Canada to learn more.

To make sure you get accurate and helpful information, this guide has been edited by Stacie Hurst as part of our fact-checking process.

Written by

Ceri Stanaway

Writer

Ceri Stanaway is a researcher, writer and editor with more than 15 years’ experience, including a long stint at independent publisher Which?. She’s helped people find the best products and services, and avoid the pitfalls, across topics ranging from broadband to insurance. Outside of work, you can often find her sampling the fares in local cafes. See full bio