What is the impact of rising interest rates on businesses?

interest rates

Inflation is a global issue, especially since the recovery from the last few years and the onset of other geopolitical crises. One of the most effective ways to combat inflation and reduce the cost of commodities, goods, and services is to increase interest rates.

Interest rates are controlled by the central banks of fiat currencies like the US dollar and the British pound. In the American economy, a lot hinges on the decision-making of the Federal Reserve, which acts as the central bank for the US dollar. The US dollar is comfortably the most traded fiat currency on the planet due to its intrinsic links to a host of precious, hard, and soft commodities worldwide, as well as its notorious trading partnerships with its European and Asian allies.

To that end, the US dollar is often used as a benchmark for the global economy. The strength of the USD is best monitored by checking the DXY, which is an index comparing the value of the dollar against other leading currencies like the Euro, the British pound, and the Japanese yen. When the Federal Reserve hikes interest rates on borrowing for USD, this usually strengthens the value of the dollar. That’s because America typically exports more than it imports. Those trading and borrowing in USD will therefore have to pay more for their goods and services.

The benefits of rising interest rates for businesses

It’s true that increased interest rates can offer some potential opportunities for businesses. Below, we’ll explain which types of businesses may benefit most from a higher interest rate environment:

Greater returns for businesses with ‘floats’

For businesses that operate with floats i.e. double-counted money, it’s possible to benefit from increased interest rates on income that may take some time to process or clear between payers and payees. If funds are held in accounts for longer prior to clearance, businesses can accrue greater interest that can be reinvested in expansion plans at a time when others are having to tighten their belts.

Greater resources for firms with negative working capital

Any business that boasts excess cash on its balance sheet may be able to generate a better return. Excess cash flow sitting in a business bank account with a greater rate of interest is good news, allowing businesses to earn more money for squirreling their surplus funds away for a rainy day.

Invest positive cash flow into lucrative securities

Businesses with a positive cash flow also have greater flexibility to reinvest that money into securities with a greater yield curve than before. These types of businesses flourish in high-interest-rate environments as they can grow their positive cash flow while retaining a sense of day-to-day liquidity.

The drawbacks of rising interest rates for businesses

Although a hike in interest rates can be beneficial for certain companies, there are just as many downsides that can come into play and affect particular business models. Below, we’ll explore some of the biggest negatives to be aware of in a high-interest-rate environment:

It can become harder to service existing debt

Businesses with existing debt can find rising interest rates particularly stressful. That’s because the costs of servicing this debt will often rise because of increased interest rates. Businesses may find they use too much of their surplus capital to pay off debt at higher rates of interest.

In a worst-case scenario, businesses may be obliged to spend too much in repayments, leaving not enough to invest in new products or services, as well as marketing campaigns or promotional material. In fact, some businesses may even need to take drastic measures such as redundancies to reduce their fixed costs to service ongoing debts.

Growth rates are often stunted

One of the biggest problems with higher interest rates is that this acts as a deterrent to economic growth. With monetary supply increasingly constrained, demand begins to dry up for goods and services, thereby affecting the bottom lines of businesses of all shapes and sizes. Businesses, therefore, suffer sluggish growth within higher interest rate environments.

Lending becomes a bigger issue when it comes to commercial loans to businesses. Banks and other lenders place more stringent affordability criteria on loans with higher interest rates, which makes borrowing more expensive and therefore less achievable for some businesses. Subsequently, ambitious businesses may not be able to secure the lending they need to take that next step on their growth journey. Instead, they may decide to take the opposite approach and scale back their plans and ensure they operate with optimal efficiency during times of economic uncertainty.

The International Monetary Fund (IMF) published a report stating that global interest rates look set to return to pre-pandemic levels in the coming years, once central banks have assumed control of ongoing inflation. This would be a major boost to businesses that have had to tighten their belts and enter ‘survival mode’ in the last 12 months.