How Inflation and Rising Interest Rates Hurt Small Businesses
The Federal Reserve, in its Federal Open Market Committee (FOMC) statement earlier this month, said inflation remained “elevated, reflecting pandemic-related supply and demand imbalances, the rising energy prices and broader price pressures”.
Russia’s invasion of Ukraine is causing enormous human and economic hardship there, but domestically the implications for the US economy are uncertain. The FOMC statement indicates that in the short term, the invasion and related events are likely to create additional upward pressure on inflation and weigh on economic activity.
Inflation is the number one concern of small business owners, according to a recent survey conducted by the US Chamber of Commerce. To cope with inflation, 67% of small businesses raised their prices, according to the study. Another four in ten (41%) say they have downsized or taken out a loan in the past year (39%) in response to mounting inflationary pressures.
“Having survived the pandemic, small business owners are now being hit by runaway inflation. This limits their purchasing power and forces small businesses to raise their own prices and absorb higher costs with already thin margins,” said Neil Bradley, director of policy at the U.S. Chamber of Commerce.
Costs for materials, inventory, labor and fuel continue to rise, straining even profitable businesses.
“There are many more vacancies today than before the pandemic, despite the fact that the current unemployment rate is higher,” said Fed Chairman, Pro Tempore, Jerome H. Powell. “A record number of people are quitting their jobs every month, usually to take up other better paying jobs. Nominal wages are rising at the fastest rate in decades, with the gains being greatest for those at the bottom of the wage scale.
Often those at the bottom of the pay scale are the workers in the smaller mom-and-pop shops. Thus, wage inflation significantly hits the smallest of small businesses.
Additionally, Powell explained that inflation rose sharply in the fall, and since the December FOMC meeting, the median projection for year-end 2022 has risen from 2.6% to 4.3%. .
“In my view…forecasters have grossly underestimated the severity and persistence of supply-side frictions, which, combined with strong demand, especially for durable goods, have produced surprisingly high inflation,” he said. Powell said in his post-FOMC statement.
The Fed seeks to achieve maximum employment and a 2% inflation rate over the long term. As a result, the FOMC has decided to raise the target range for the federal funds rate to 1/4 to 1/2 percent and expects continued increases to be appropriate. The Committee will continue to monitor the implications of the continued impact of COVID on public health, labor market conditions, inflationary pressures, and financial and international developments.
The need for stable and ongoing funding is something that business owners will face for the foreseeable future. The environment of inflation and higher interest rates we find ourselves in today is a challenge for small business owners. Costs continue to rise due to ongoing supply chain issues and labor shortages.
Fed rate hikes will in turn increase the cost of borrowing for small businesses. These rates are already well above the benchmark rate for mortgages, for example. This could drive the minimum funding cost to around 9% APR. The new rates don’t just apply to new loans originated this year; these higher rates will apply to existing loans, as most business lenders have floating or variable rate financing products.
SBA products will increase in rate as these interest rates increase. Even business owners who don’t plan to expand soon should get a head start and get approved for a financing option now rather than later.
Women business owners, in particular, should pay close attention to these economic trends. Earlier this month, Biz2Credit released its annual Women’s Small Business Survey. It found that revenues for women-owned businesses fell 26% in 2021 compared to 2020, and credit scores also declined. Having lower credit scores can prevent you from getting the lowest interest rates.
Looking ahead, given that the Fed has signaled its willingness to continue raising rates, business owners should keep in mind that most small business loans and SBA products are issued at variable rates. They need to take the rising cost of capital into account in their decision-making.
While the interest rate spread can be anywhere between the mid and high digits all the way up to the double digits, but the rates may not be the deciding factor. Instead, for some businesses, the most important factor is very often immediate need, including the opportunity cost of losing property or obtaining inventory at a reasonable price through prepayment. This has become increasingly important at a time when supply chain issues are driving up the costs of raw materials and finished goods.
We know how the interest rate environment has evolved since the middle of last year. Borrowing rates have been close to zero for many years and low-cost money has flowed into businesses for a long time. We haven’t seen a significant rate hike pattern since 2018, a pre-pandemic period that seems a very long time ago. If small businesses can get fixed-rate financing today, they should take advantage of the opportunity, as rates will likely continue to climb as the Fed establishes policies aimed at slowing inflation.