Effects of inflation, interest rates, money supply on investment performance
THEY are various macroeconomic variables that can boost investment and ultimately influence stock market performance. These variables entail inflation, money supply, interest rates and investor expectations. This article will attempt to elucidate these in detail.
Inflation on investments
A stable low inflation rate stimulates investment in the country because there is price stability and hence investors have confidence leading them to invest on the stock market and improving performance of the stock market.
High GDP per capita implies that the households have more disposable income leading to a higher average propensity to save ratio.
High savings in the economy stimulate investment because investors have an appetite for assets with expected higher returns rather than hoard money in form of cash and bank balances which does not yield returns.
When domestic savings are high it leads to better stock market performance because of the need to earn returns on savings hence increasing investments in equities.
Interest rates on investments
Interest rates also have significant impact on the performance of stock markets. Stock markets are classified as high risk instruments hence the negative relationship with interest rates.
When firms are profitable, their share price increases hence investment in the firms because of investor expectations on dividend and share price growth.
Stock markets and money markets are close substitutes, with the interest rate being the rate of return for money.
When there is a low interest rate inves
tor will move to stock markets in search of higher returns resulting in better stock market performance.
Expectations and sentiments on investments
Investor sentiment and expectations affect stock markets. When investors expect changes in government policy with emphasis on the fiscal and monetary policy, the information is fully reflected in share prices, for example expansionary monetary policy leads to improved stock market performance because of the provision of low interest rates.
Industry performance has a major effect on stock market performance because on portfolio allocation theory it states that investors will tend to invest in profitable sectors where there is a provision of higher dividends.
Industry performance affects stock market performance because firms in the same sector are affected by the same market conditions.
The interest rate and stock markets are the two important macroeconomic variables with a focus on investments and savings in the broader economy.
Through monetary policy, interest rates affect the degree of the economy through investments and savings as transmission mechanisms hence stock markets and money markets.
Money supply on investment
The money supply is the aggregate total of all of the currency and other liquid assets in a country’s economy.
The money supply includes all cash in circulation and all bank deposits that the account holder can easily convert to cash.
Governments issue paper currency and coins through their central banks or treasuries, or a combination of both. In order to keep the economy stable, banking regulators increase or reduce the available money supply through policy changes and regulatory decisions.
An increase in the supply of money typically lowers interest rates, which in turn, generates more investment and puts more money in the hands of consumers, thereby stimulating spending.
Businesses respond by ordering more raw materials and increasing production. The resultant of this series of increases spending leads to an increase in equities investments and hence stock market enhancement. Change in the money supply has long been considered to be a key factor in driving economic performance and business cycles.
The quantity theory of money formalises the link relating money supply and stock prices.
When there is an increase in money supply, there will be a surplus in the quantity of money and this will encourage people to demand more shares and thus cause an increase in share prices.
The liquidity hypothesis also suggests a positive relationship between the variables.