The day of reckoning--and high interest rates--is here and has been here for some time. Small business owners are plagued by inflation and peak rates of 5.25% to 5.5%, the most aggressive cycle the U.S. has seen since the 1980s. Rates have maintained this threshold since July 2023 as a way to combat inflation.
Earlier this year the Fed projected the fed funds rate may cut to 5.1% by the end of 2024. However, the Central Bank wants more data, particularly employment numbers, before it lowers interest rates.
Interest Rates and Small Business Owners
The past few years have been an interesting economic climate for the U.S. economy. The Fed slashed rates to near zero (0-0.25%) during the pandemic and kept them low to encourage economic recovery and spending through 2022. But that changed in March 2022. They raised interest rates 11 times between March 2022 to July 2023 to their current peak. These fed rate hikes accompanied high mortgage rates, high-interest debt, housing demand and housing prices as well.
Regardless of a potential cut coming before the end of the year, small business owners cite high rates and inflation as their most current and formidable challenges. About 58% of small businesses report that current interest rates hurt their daily operations. “Getting a loan these days costs far more than it’s worth,” one tree care company owner wrote. They added,“[I’d] rather rent equipment than buy it due to the prices.”
For longtime businesses, high rates make it a challenging time to upgrade equipment or hire staff. Startups or younger businesses cannot afford the current cost of capital. Even more, banks and lending institutions are tightening their credit boxes.
One retail owner indicated high rates and low profits as the small business death knell, especially for her market in Iowa. She explains, “There is only so much a Midwestern consumer is going to spend on an item.” She continues, “We have to pay more to get the items, but we can’t recoup all of that with a price hike because we would lose even more sales.”
Others saw the high rates hurting customer demand. “People seem to be in a wait-and-see mode,” said one business owner. “They’re sitting on their hands and not making big financial decisions.
Industries Impacted Most by Interest Rates
The impact of high interest rates varies by sector. For instance, the construction, retail and hospitality sectors are particularly vulnerable due to their reliance on credit for growth. Higher borrowing costs have slowed new construction, particularly residential projects. Small construction firms report difficulties in securing affordable loans, which delays or cancels their project dockets. Likewise, some report hesitance to invest in new equipment and technology.
Hotels and restaurants are also challenged by high rates for equipment and capital improvements. Many report that tight margins are overrun by increasingly high operational costs.
What to Expect in Future Interest Rates
Regardless of the sector, it’s important for small business owners and lenders to prepare for economic cycles when borrowing costs are particularly high.
The following are simple ways an entrepreneur can decipher economic outlook and determine whether a rate hike or decrease may be in their future.
- Gradual Increases: Economists predict a gradual rise in interest rates as the Federal Reserve combats inflation, impacting borrowing costs over the next few years.
- Economic Conditions Impact: Factors like inflation, employment rates, and GDP growth will influence interest rates, with a robust economy likely leading to higher rates.
- Federal Reserve Policy: Changes in the federal funds rate by the Federal Reserve will significantly affect future interest rates.
- Global Factors: Global economic conditions, including trade dynamics and geopolitical events, can impact U.S. interest rates.
- Inflation Trends: Persistent inflation may lead to more aggressive rate hikes by the Federal Reserve, increasing borrowing costs.
- Market Expectations: Financial markets often anticipate and react to expected changes in interest rates, so staying informed about market trends and forecasts is crucial for business planning.
Preparing for High Rates
A small business owner is directly and dramatically impacted by inflation and high interest rates. From profit margins to employee compensation, consumer spending to cost of capital, an owner’s bottom line is directly correlated to their economic conditions.
Small business owners can take the following strategic caution to prepare for high rates or inflation:
- Flexible Financing Plans: Create financing plans that adapt to changing interest rate environments, maintaining a mix of fixed and variable rate loans. Consider lower price options for consumers, as well, who are likely less inclined to make expensive purchases during inflationary cycles.
- Building Cash Reserves: Strengthen cash reserves to reduce dependency on borrowing and provide a buffer against rising interest rates.
- Negotiating Loan Terms: Proactively negotiate loan terms with lenders to secure favorable conditions before rates increase further.
- Investing in Efficiency: Invest in operational efficiencies and cost-saving measures to improve profitability and reduce the impact of higher borrowing costs.
By understanding current trends and preparing for potential future changes in interest rates, U.S. business owners can navigate the financial landscape more effectively and ensure their businesses remain resilient.