The relationship between policy rates and stock valuations is a fundamental concept in financial markets. Policy rates, set by central banks, directly influence the cost of borrowing and the overall level of liquidity in the economy. When policy rates are low, borrowing becomes cheaper for businesses and consumers. This encourages investment, expansion, and spending, which can boost corporate earnings and, in turn, increase stock valuations.

Lower interest rates also make fixed-income investments like bonds less attractive compared to equities. As a result, investors often shift their funds into the stock market in search of higher returns, pushing stock prices higher. Additionally, lower rates reduce the discount rate used in valuing future cash flows, which increases the present value of stocks, especially growth companies.

On the other hand, when policy rates rise, borrowing costs increase. Companies may reduce investment, and consumers may cut back on spending, which can negatively affect corporate profits. Higher rates also make bonds and savings instruments more attractive, leading investors to move money out of stocks. This often results in declining stock valuations.

Moreover, rising policy rates increase the discount rate applied to future earnings, reducing the present value of stocks. Overall, there is generally an inverse relationship between policy rates and stock valuations, although the impact can vary depending on economic conditions, inflation expectations, and investor sentiment.