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Economics

Interest rates: how the rise might affect your business

What will be the impact for businesses of the cost of living crunch?

Some estimate that the Bank of England will raise its base rate to as much as 6% by 2023 to try to manage inflation. Currently, the rate stands at 2.25%, its highest level for 14 years.

Only last December, the bank rate was as low as 0.1%, so what has happened? Several factors have come together forcing the general price level to rise.

According to our Economists, the economic environment was already feeling the pressure from demand rising as Covid restrictions eased, coupled with supply weakened by large parts of the economy having been shut down for so long. Recent catalysts such as Russia’s invasion of Ukraine have intensified this pressure and caused the prices of energy, food and other goods to rise sharply, contributing to a large hike in inflation and triggering a cost of living crisis.

The current rate of inflation is around 10%, well above the 2% target of the Bank of England, which will continue to increase interest rates to help curb this inflation. The aim, quite simply, is to ease inflationary pressures by slowing economic activity. This is done through tempering demand, as higher interest rates will deter people from borrowing and spending, instead encouraging them to save, and will deter businesses from investing.

What support is there for business?

The government’s Energy Bills Support Scheme should help to curb inflation by capping ever-rising energy prices. But the danger is that money not spent on bills can be spent elsewhere, meaning the Bank of England may need to raise rates even higher. Managing inflation is a complex operation; it is difficult to say how long this situation will last, as ongoing factors, such as the war in Ukraine, continue. Despite this uncertain economic future, the Bank of England will continue to monitor the situation closely and will review interest rates regularly.

How will interest rates affect my business?

Rising interest rates affect businesses though several channels.

  • Firstly, it can affect their top line, as slower economic activity is likely to lead to lower demand for their goods or services; people will be reluctant to shop on credit, and while people with savings will see a ‘wealth effect’ of higher returns, these interest rates have not yet caught up with rising prices.
  • Secondly, businesses will face higher borrowing costs, further eroding margins.
  • Lastly, even if businesses are not impacted directly, they may still experience second-hand effects due to the increased prices of goods from suppliers, and will be forced to increase their own prices, and/or face supply disruptions. This could push inflation even higher, further eroding sales.

There is still time for you to assess how rates might affect your business now and in the future.

Areas for businesses to consider as interest rates rise

Revisit your business plan

Are your objectives flexible enough to withstand the current headwinds? Take a good look at your existing business strategy and consider whether it still applies. Assess the type and levels of your debt.

Businesses should be prepared for every eventuality and aware of the risks of overextension when borrowing in an environment conducive to rising rates. With an increase in interest rates, businesses with company credit cards and existing loans can have higher interest payments, less disposable income and bigger overheads. In some cases, borrowers may find themselves paying off the interest only, rather than the loan itself.

Increased interest rates could also see businesses opting for shorter-term loans tied to cash flow and presenting greater risks, potentially leading to further negative impacts.

You can contact your relationship manager to discuss whether your available capital is enough to sustain you.

Watch the value of the pound⁠

Higher interest rates can increase the value of currency. If businesses have income streams in foreign currencies, then rising interest rates, and in turn rising sterling, will affect a company’s profits.

Forward contracts can be used to mitigate the risk of exchange-rate differences where your business has foreign currency transactions.

Keep an eye on your supply chain⁠

If prices increase, or payment terms and accounts payable change, companies need to be aware that while they might be relatively insulated, their key partners, ie their customers and their suppliers, might not.

Even if your company has no funding affected by interest rate changes, your suppliers may do, and your costs may increase to cover higher interest charges. Having contracts in place to fix supply prices can mitigate this risk.

Nevertheless, interest rate rises can force companies’ hands, with inflation driving up the pricing of manufacturing, distribution, and business services, which then trickles down the business supply chain.

This material is published by NatWest Group plc (“NatWest Group”), for information purposes only and should not be regarded as providing any specific advice. Recipients should make their own independent evaluation of this information and no action should be taken, solely relying on it. This material should not be reproduced or disclosed without our consent. It is not intended for distribution in any jurisdiction in which this would be prohibited. Whilst this information is believed to be reliable, it has not been independently verified by NatWest Group and NatWest Group makes no representation or warranty (express or implied) of any kind, as regards the accuracy or completeness of this information, nor does it accept any responsibility or liability for any loss or damage arising in any way from any use made of or reliance placed on, this information. Unless otherwise stated, any views, forecasts, or estimates are solely those of the NatWest Group Economics Department, as of this date and are subject to change without notice.

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