After years at record low levels, interest rates had begun to move higher. But now the direction of travel looks uncertain once more, and that could affect your business.
Interest rates have been held at record lows in the years since the financial crisis, as developed market central banks took action to shore up the global economy. But, more recently, the trajectory of interest rates has begun to change course. At the end of last year, markets began bracing for global interest rates to move higher. The U.S. Federal Reserve had already embarked on a rate hiking cycle in 2015, while last summer the Bank of England raised the United Kingdom's base rate to 0.75%, and markets had been pricing in further increases from both central banks this year.
But now, in the face of weaker global growth, the United States has begun cutting interest rates again for the first time in a decade, and has left the door open to further policy action, while Eurozone policymakers are also talking about loosening policy. In the United Kingdom, what happens with Brexit could determine which direction its central bank takes on rates. In 2019, Bank of England governor Mark Carney warned people should not underestimate the likelihood of higher interest rates in three to five years' time. However, two of the Bank's key policymakers recently voted to cut rates again, and Carney has said he would consider a cut if global and Brexit headwinds don't abate.
All this makes for a confusing time for business owners wondering what it might mean for their borrowing. If rates are going up in the long term, could your business withstand an increase in your variable rate borrowing? But if they are going down in the short term, should you lock in low rates now with a fixed-rate loan or commercial mortgage, or think about consolidating existing borrowing?
A Ripple Effect
Central banks know there is always a ripple effect for companies—and the consumers that buy their products and services—whenever interest rates move. Higher rates mean a higher cost of capital for businesses, plus greater household debt costs and less discretionary spending power for consumers. For this reason, whether interest rates go up or down, usually policymakers only move them gradually and incrementally, to try to avoid any shocks to business, which could in turn destabilize the economy.
From a business owner's perspective, this might not provide enough reassurance. It's a good idea to be proactive and review your borrowing regularly to make sure you would not struggle to make repayments if the cost of borrowing suddenly increased. Look at whether any debt you may have is still the right fit for your business—whether it takes the form of loans, credit cards, bridging finance, a commercial mortgage or hire purchase. Are you over-leveraged or, indeed, under-leveraged? Ideally you want to find your happy medium, as there are downsides to too much borrowing and too little.
If you're likely to need new borrowing in the next few years, affordability could be an issue if rates are higher, and this could be an obstacle to your company's growth. In that case, it might be better to either borrow now to lock in a lower rate, or try to make cost savings elsewhere so you can build up a buffer of excess cash to fund future expansion, and hopefully earn a little more interest on it in the meantime. Alternatively, you might decide to put the brakes on investment spending in an environment of more expensive borrowing costs.
Refinancing your existing borrowing during a time of low interest rates is worth considering, but whether you get the best rates may depend on the level of your debt, and the trading history and credit record of your business. Think carefully about consolidation, especially if you're doing it to facilitate more borrowing. Cheaper borrowing is obviously better, but do you really want to extend the term of a loan for a lot longer to keep your monthly repayments down? Could it hinder you from expanding your business and grabbing any opportunities that may come your way in future?
Business owners are busy people and may struggle to find the time to shop around for the best deal when it comes to consolidating or refinancing borrowing, so you could consider using a broker to help you find better sources of business finance; you could recoup their fee quickly in the interest payments you save.
Long-Term vs. Short-Term Borrowing
Higher interest rates can make long-term borrowing more expensive, and short-term borrowing harder to obtain. A lack of short-term funding options can be problematic for businesses that struggle with day-to-day cash flow, perhaps because of late-paying clients or fluctuating seasonal sales. Firms like these typically use short-term borrowing to bridge cash flow gaps so they can continue to pay their staff and suppliers, order inventory and keep their business running smoothly. Long-term debt on a variable rate, on which the payments are going up, can squeeze a company's profitability—and this may make it harder to secure future borrowing at competitive rates.
It's a good idea to be proactive and review your borrowing regularly to make sure you would not struggle to make repayments if the cost of borrowing suddenly increased.
It's hard to know what the backdrop to business borrowing will be over the next few years as banks flip-flop between tightening and loosening policy. Business owners will need to keep a watchful eye on the situation and their finances to make sure their borrowing is always fit for purpose.
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