How Interest Rates Impact the Art Market

Earlier this month, the U.S. Federal Reserve made the decision to cut interest rates by 0.5%. This cut is the first since the early onset of the COVID-19 pandemic. It means that the base rate—what the Fed charges banks to borrow money—now sits between 4.75% and 5%.

This change, which follows similar moves from other central banks such as the Bank of England, is expected to have an impact on everything from credit cards to mortgages and will have a ripple effect on the global economy.

The art market, which tends to thrive in lower interest rate environments, is likely to be impacted. Here, we explain the basics of interest rates and how they impact the art market.

What are interest rates?

Simply put, interest rates are the cost of loaning money or the return on investing money, expressed as a percentage. When taking out a loan, a lender will offer a rate that is charged as compensation for supplying the funds. For example, if you take out a loan of $1,000 with an annual interest rate of 5%, you’d pay back $50 in interest over one year.

When investing or depositing money in a savings account, interest is earned as compensation from the bank where it is held. So, for example, if you deposit $1,000 in an account with a 5% annual interest rate, you will earn $50 in interest after a year.

The main factor influencing interest rates is central bank policy. Central banks—such as the Federal Reserve in the U.S., the Bank of England in the U.K., and the European Central Bank in the E.U.—set what is called a base rate for their jurisdictions. These rates act as a benchmark for the cost of borrowing money between commercial banks and have a direct impact on the fees that these institutions charge their customers.

A higher base rate makes it more expensive for banks to borrow money, which is passed on to the consumer. A lower base rate, meanwhile, makes the cost of loans cheaper, encouraging investment and spending.

The setting of interest rates is primarily influenced by inflation. When interest rates are high, people and businesses are more likely to spend and invest less, because it is more expensive to borrow money. This leads to a slowing of demand and therefore a deceleration of price rises, which lowers inflation. When interest rates are lower, money is cheaper to borrow and economic activity is stimulated, increasing investment and spending. But this can lead to an increase in demand, which, in turn, can lead to a rise in prices, causing an uptick in inflation.

Interest rates have fluctuated heavily in recent years. Rates were slashed to historical lows in the early 2020s—as low as 0.25% in the U.S.—to stimulate economic activity during the COVID-19 pandemic. Then, around 2022, inflation reached the highest levels in decades. This was caused in part by disruptions to supply chains and geopolitical events such as the war in Ukraine. Higher rates followed and by May 2023, the Federal Reserve had raised rates to 5–5.25%.

The art market has an intricate relationship with interest rates.

Higher interest rates, such as those seen in recent years, can cause the art market to stiffen. In other words, because higher rates make it more expensive to borrow money, the liquidity of and spending on luxury goods such as art can become constrained.

“The current cost of capital being so high makes it much less attractive to borrow for acquisition purposes unless our client believes that the opportunity on the purchase is so tremendous that they can’t ignore doing it,” said Jim Carona, director of the Palm Desert–founded gallery Heather James Fine Art.

Art is classified as a non-liquid asset, meaning that it doesn’t generate instant cashflow. This increases the risk of investing in art during a period of high interest rates when assets with more stable returns—such as government bonds—are favored. During high interest rate periods, many collectors can also find themselves less liquid, said Drew Watson, head of art services at Bank of America. He noted that in recent high interest rate years, some buyers “could not participate in the market to the extent they had previously, resulting in less depth of bidding and lower prices.”

This impacts the sell side of the market, too. Collectors become less likely to put works up for sale because they view the market as less favorable, and worry about the ability to sell their work for a strong price, such as in recent high interest rate periods. “Sellers are less willing to bring large single-owner collections and trophy works to market unless they have to,” said Watson.

The effects of high interest rates can be seen at the top end of the auction market, where inventory with estimates in the six figures and above is typically consigned. In high interest rate periods, those top lots are less likely to go to auction. Last year, for instance, the top 100 lots at auction totaled $2.4 billion, which was a steep decline from $4.1 billion in 2022, when interest rates were at record lows at the start of the year.

That being said, art is often viewed as a hedge against high inflation because it is perceived as having a long-term store of value. When demand can soften as a result of lower liquidity and higher rates, collectors can take advantage of lower artwork prices. From an investment perspective, this is often viewed as an attractive long-term play, where these works can accrue value over time.

In a lower interest rate environment, borrowing money becomes cheaper and can boost liquidity in the art market. “When interest rates were near 0%, our wealthiest clients could borrow for less than 1%, either using their existing art collection as collateral or using the funds for new acquisitions,” said Carona. “At that time, there was a tremendous amount of liquidity being pumped into the system.”

Low interest rates also create what is known as the “wealth effect.” This comes about when lower rates lead to an increase in the value of assets such as stocks and real estate, resulting in higher spending on luxury goods such as art. Many collectors are influenced by the gains in their financial portfolios that can be seen during these periods. “Buyers have more liquidity to bid for major lots, thereby increasing competitive bidding and realized prices,” said Watson.

Low interest rates have also historically increased the demand for alternative investments like art, which is another factor leading to increased demand and rising prices. Sellers are more likely to take advantage of this environment, adding to the liquidity in the market. “Auction houses have more capital to coax more trophy works and major collections to market with guarantees,” said Watson. “Sellers see greater depth of bidding and feel more confident bringing more high-value supply to market.”

Carona points to the low interest rate environment of 2020–2022 as an example of this. “The market was being flooded by liquidity from the Federal Reserve, and at the same time interest rates were essentially zero,” he said. “This was the catalyst for the incredible run-up we saw in art prices across the board, but most prominently in young artists under 45 years of age.”

Auction performance can mirror the public picture of what many galleries also notice privately during low interest rate periods: that collectors are more liquid, and spend with increased confidence. These factors can also lead to a shorter sales cycle, noted James Ward, director of London’s JC Gallery. “The thing I notice most is the length of conversion time for a sale,” he said. “A greater depth of thinking time is taken when the interest rates are higher. Once rates are cut, there’s an underlying positivity in purchasing.”