By most measures, the S&P/ASX 200 Index (ASX: XJO) has had a great year in 2025.
For one, the index has recovered from its 2025 lows to hit new all-time highs this year, the most recent of which was the 8,639.1 point high watermark we saw earlier this month.
Yesterday, the ASX 200 closed just short of that all-time high at just above 8,538.60 points.
For another, we've seen a bevvy of prominent blue chip ASX 200 shares hit new highs of their own. The most famous of these (or perhaps infamous, depending on who you speak to) is, of course, Commonwealth Bank of Australia (ASX: CBA).
But we've also been multi-year, or record, highs for shares ranging from National Australia Bank Ltd (ASX: NAB) and Coles Group Ltd (ASX: COL) to Telstra Group Ltd (ASX: TLS) and Wesfarmers Ltd (ASX: WES).
Today, many of these shares look expensive, and are trading on some of their lowest dividend yields we've seen in a very long time.
It's arguably quite difficult to find bargain buys on the ASX today.
Even so, I still wouldn't be surprised if the ASX 200 keeps on climbing this year. We could even see the index break 9,000 points for the first time ever.
Why? Well, it comes down to one factor – interest rates.
At the start of 2025, the Reserve Bank of Australia (RBA) had the cash rate at a 13-year high of 4.35%.
However, thanks to a rate cut in February and another in May, the cash rate now sits at 3.85%. Most commentators expected the RBA to go three for three this week. However, to most experts' surprise, it held steady.
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How interest rates could drive the ASX 200 to 9,000 points.
Despite this pause, experts are still confident that more cuts are coming. Just today, my Fool colleague Laura looked at what the big four banks are pencilling in. All four are expecting at least two more cuts by the end of 2025, with Westpac Banking Corp (ASX: WBC) expecting the cash rate to drop as low as 2.85% (implying four cuts ahead) by May of 2026.
But what do rates have to do with the ASX 200? Well, quite a lot.
Legendary investor Warren Buffett once described interest rates as acting like gravity on all investments, including shares. Here's some of what he said back in 2016:
[A low interest rate] does have an effect of making all assets more valuable. Interest rates are like gravity in valuations. If interest rates are nothing, values can be almost infinite. If interest rates are extremely high, that's a huge gravitational pull on value.
This 'gravity' functions in two ways.
Firstly, the prevailing cash rate represents a 'risk-free' rate of return that investors usually benchmark against when evaluating an ASX share. If that rate increases, the value of the shares needs to be lower to compensate for the extra risk that comes wth investing in a stock.
Conversely, if rates fall, it has the opposite effect on valuations.
Secondly, the higher interest rates are, the more attractive it is to invest money outside the share market. Think about it. If you have an ASX dividend share that yields 5%, many investors will want to own it if all they can get from a savings account or term deposit is a 3% interest rate.
However, if rates rise and a term deposit now yields 5%, there are many investors who won't want to take the additional risk of owning the shares when they can get a guaranteed 5% from the bank.
Foolish takeaway
If the RBA does indeed cut interest rates two or more times this year, it wouldn't be too much of a stretch to see the ASX 200 rise even further over the rest of 2025, perhaps even to 9,000 points. Particularly if investors price in another few cuts for 2026.
This is just a humble educated guess. There's every chance that the markets end up going backwards over the rest of 2025. Or else stay just where they are. But I wouldn't be surprised if the modest momentum we've seen over the year so far continues, thanks to the RBA.
