The Federal Reserve slashed interest rates for the first time since 2020 on Wednesday, September 18th. The large, one-half percentage point reduction is a policy signal that additional interest rate cuts may be on the way, especially for households and business owners who are struggling with inflation. With Wednesday’s action, the Fed’s benchmark interest rate will stand between 4.75% and 5%. These are still the highest numbers since 2007.
Interest Rates Encourage Small Business and Consumer Behavior
Reasons for cutting higher interest rates include a slowing economy and rising unemployment numbers. Still, rate cuts are good news for small business owners who have been fighting historically high supply and labor costs. Likewise, lower interest rates may encourage consumers to purchase high-ticket items; and for lenders to have a more liberal platform to offer small business financing. Small businesses acquire less costly capital for start-up costs, equipment upgrades or real estate expansion when rates are favorable.
A better interest rate is also good news for consumers who choose to purchase their homes or cars when the annual percentage rate is lower. The downward decline toward 6 percent is “reviving purchase and refinance demand for many consumers,” Sam Khater, Freddie Mac’s chief economist, said in the company’s statement. Yet while the 30-year term is hovering around six percent, the base rate is still almost twice as high as it was three years ago during the pandemic. As a result, potential sellers remain unwilling to part with lower rates on their existing mortgages and put their homes on the market.
Also, while homeowners hoped mortgage rates would also drop, the 30-year fixed-rate mortgage is closely tied to the rate on the 10-year Treasury and unaffected by a change in the fed’s short-term rate. Regardless, analysts at Oxford Economics indicate that with interest rates toward 6 percent, prospective sellers may be more willing to list their homes, which will likely boost inventory.
Fed chair Jerome Powell said the outsized interest rate cut marks a "strong start" to protecting strength in the economy. Though small business generally celebrates the relief, most economists believe the real impact--from home ownership to Main Street--won’t be felt until the end of year or into the first of the year, 2025.
Here’s What Small Business Can Expect from the Interest Rate Cuts:
More Spending and Borrowing
Because reduced borrowing costs cause an uptick in consumer spending, the surge in spending can stimulate demand. This benefits businesses and potentially leads to job creation. Likewise, the cost of borrowing is better for small businesses who pursue anything from a microloan to a line of credit.
Business Investment
For businesses, lower interest rates can facilitate easier access to capital for expansion projects and operational investments. Companies might be more inclined to finance new initiatives or upgrades, driving innovation and productivity.
Market Reactions
Financial markets often react quickly to changes in interest rates. For small business lenders, rate stability generally encourages lending activity. Borrowers are also less likely to hesitate before submitting loan applications. This demand, however, can often change a lender’s credit box. As it relates to the exchange, if investors perceive the rate cut as a sign of underlying economic weakness, it could trigger volatility in the stock market.
Inflation and Long-Term Effects
While the immediate effects of the rate cut may seem beneficial for small business owners, there are concerns about potential inflationary pressures on the Fed. Sustained low rates can lead to increased borrowing and spending, which could drive prices up over time. The Fed will balance growth stimulation alongside the risk of overheating the economy. Beth Ann Bovino, chief economist for U.S. Bank says, “The feeling that people have in supermarkets is still very real. It still hurts... It’ll take some time before people get back in control of their finances.”
Global Considerations
In a global context, lower interest rates can affect currency values and international trade dynamics. A weaker dollar may make U.S. exports more competitive, but could also increase the cost of imports, which leads to increased inflation at home.
What’s Next for Interest Rates?
The interest rate cuts will likely increase the appetite for traditional lenders as they rebalance their portfolios. More lending means more borrowers; and lower interest rates means reduced interest payments for small business owners. Because most small business loans are variable rate loans, the steady stream of the Fed’s rate hikes increased the cost of loan repayments and reduced earnings. A reduced interest payments for businesses should positively increase their earnings in the short term. In effect, the stakes surrounding the recent interest rate cut are significant, as they hold the potential to influence consumer behavior, business investment, market stability, and long-term economic health. The news is long-anticipated and especially welcomed by small business borrowers, who should see more immediate financial benefits.