On November 2, the Bank of England announced that it has raised interest rates for the first time in over a decade from 0.25%, to 0.5%. While it’s a small adjustment, this news has been met with alarm in the UK and in financial markets, resulting in an immediate and unexpected drop in the value of the pound.
Though a small rate hike of 0.25% doesn’t look significant, it bears a lot of significance for UK consumers and small businesses. Small business owners can expect to feel the squeeze on multiple fronts as consumers’ confidence weakens, credit becomes more expensive, and inflation slows down. This is because changes in interest rates influence nearly every aspect of the economy, so even a small change can transform the perception and behavior of both businesses and consumers.
1. The cost of credit increases
By increasing the interest rate, the Bank of England is directly increasing the cost of credit. This makes it more difficult and less profitable to borrow for your business, whether it’s to finance growth or to stabilise cash flow. These direct costs are likely to be relatively small, but could become significant if the interest rate continues to rise.
The area where real pressure will be applied is on existing debt. Major existing loans with variable interest rates, such as mortgages and business loans, can suddenly become far more expensive to service. These increased costs can break carefully optimised budgets, and could result in financial hardship for UK businesses that operate on thin margins.
2. Consumer confidence drops in time for the holidays
Just as businesses find themselves with slightly heftier bills to pay, consumers will also find themselves looking at some unexpected increases in their own mortgage payments. Moreover, the increased cost of credit, while still affordable compared to global rates, will impact consumer confidence and discourage people from taking on debt to finance future purchases in the near term.
For some businesses, this could turn out to be a disastrous combination. Many businesses are currently ramping up capacity to meet steep holiday demand, and often relying on financing to fund that investment. A drop in consumer confidence immediately before the holiday season could result in a slump in sales during the most critical time of year. As a result, some businesses may now find themselves overcommitted.
3. The pound weakens
Since the Bank of England has made its announcement, the pound sterling has already fallen 1% against the US dollar, and 1.5% against the euro. That sounds bad, but a weaker pound isn’t all bad news. While it means that importers will be forced to pay more for their products, exporters become more competitive internationally as their prices are automatically reduced for their foreign customers. This helps to offset some of the pressure those businesses will be feeling domestically. By ramping up international sales, exporters can recover any potential domestic losses.
Another group that benefits from this situation is businesses and workers that earn foreign currency, whether it’s because they work for or contract with a foreign company, or because they operate their own foreign subsidiaries. That same foreign revenue will simply convert to more UK currency than it did previously, giving those earners a temporary advantage until market prices adjust.
4. Inflation gets nipped in the bud
Over the last two years, the UK’s inflation rate has risen significantly. While it’s currently not alarming, it is well above the country’s target 2% inflation rate. With the uncertainty surrounding the UK’s Brexit negotiations, the Bank of England issued a statement that inflation was being driven up and needed to be stabilised.
Keeping inflation down is good for lenders, and good for savers, ensuring that saved funds retain their value relatively well over time. This is designed to help ensure that UK citizens and businesses retain their buying power as much as possible by encouraging people to save money. Of course, that also means that it can also be a problem for businesses with a lot of outstanding debt, because it also preserves the value of that debt.
While the current changes have been relatively small, the Bank of England has indicated that further rate hikes are on the horizon, though there has been little agreement on when those may occur. As the relatively tense economic situation between the UK and the rest of the EU develops, small business owners in the UK would be well advised to continue to pay close attention to changes like this, and to understand what they could mean for their business, and their own cash flows.