High Interest Rates and Your Biz: is it All Bad News?

Interest rates have been in the national headlines over the past year. Massive increases in interest rates since early 2022 have disrupted the stock market, “caused” bank failures, slowed housing purchases, and have made many business owners worried about the impact to their own situation. While mortgage rates have gone from roughly 3.5% to 6.5%, new credit card rates have surged from 16% to almost 24%! But do higher rates actually hurt small businesses? Who should be worried and is there anything to do about it? This blog looks at the ways interest rates affect small businesses, and offers a few coping strategies.

First, it is helpful to understand what is causing interest rates to climb, in order to see why and how long they may stay high. In the current case, the central bank of the U.S. (the Fed) raised rates high and fast to combat the surging inflation post COVID. Inflation hurts everyone; people and businesses all have to pay higher prices and at some point, they cry uncle and change their behavior to the detriment of everyone. As an example, over the past few years, restaurants have had to pay higher prices for everything – meat, veggies, staff, rent, etc., and therefore raise their prices on the food they serve as an offset. Customers still want to go out but now must spend more money than usual on their meal service, having less to spend on other things. They feel poorer and pressure their bosses for raises, which then contributes to higher costs for the businesses they work for. You get the idea; this could easily spiral to higher and higher prices!

These hikes are therefore necessary to put the economy in a better place, but they can also cause some pain. Which is worse – inflation pain or economic slowdown pain? History shows across many countries that inflation pain is the worst. So here we are, higher rates, lower inflation (not yet low enough), while the economy isn’t doing so badly. Where does that leave small businesses?

Higher rates can impact businesses directly and indirectly. In the direct path, if a company borrows money, that cost obviously goes up. If there are any loans, credit cards, rent payments, leasing arrangements (machines, cars, etc.), the interest part of the bill is unambiguously higher. This eats into profit margins. The more indebted a small business, the more it is likely to suffer directly from higher rates. In a higher rate environment, it’s also harder to raise money and get good terms on loans. It may be necessary to be or become self-sufficient; don’t rely on rolling over debt or loans on favorable terms. In other words, people and businesses need to have a bigger cushion of savings than usual and be prepared for tricky borrowing conditions.

All businesses can suffer indirectly from a slowing economy. After all, the whole point of interest rate hikes is to slow the economy to slow inflation. So far, the U.S. has been lucky and hasn’t felt a significant slowdown. The service industry is doing quite well, probably because the post-COVID urge to get out and do things (like travel) is alive and kicking. However, we are starting to see some slowdown in orders and inventory for manufacturing firms, which could be a warning sign. Many of the big bank economists aren’t too worried though; they have shifted to forecast a “soft landing” which means that they think the base case scenario is that the economy slows just enough to get us back to normal inflation without causing too many job losses.

Higher interest rates are likely to be around for awhile however. Businesses need to prepare and account for the impact on their borrowing and any payments that get affected by interest rates (like rent). Everyone should try to maintain a higher buffer of savings to help offset business slowdowns. One possible silver lining for those who are prepared: you may be in a position to take market share from other businesses who are maybe in too much debt, or who are stuck cutting expenses to survive. Having spare money to spend on marketing in tough times can put your business in a position to attract clients away when others can’t afford to spend on marketing. As always, be conservative in finances to weather tough times and take advantage of opportunities if your industry suffers.