Interest Rates: The Bad and Good News
One of the reasons for the recent roller coaster ride in the stock market has been the anticipation of a possible increase in interest rates. While the effect of interest rates can be seen in the trading of stocks of larger businesses on the major exchanges, its influence on smaller businesses may not be as obvious.
On September 17 the Federal Reserve decided not to raise interest rates, but it is expected to start increasing the short-term Federal Funds Rate near the end of this year. Some economists are predicting that during the next couple of years, it could reach 4%, which is considered more normal than today's level.
The Federal Funds Rate is currently at 0%. It has been at zero for the past seven years as part of the Federal Reserve’s attempt to stimulate economic recovery after the recession of 2007-2009. The fear is that a continuation of very low interest rates will lead to inflation, a deflationary debt spiral, or worse yet, a return to the borrowing bubble that contributed to the last recession and subsequent slow recovery.
While the effects of a raise in interest rates can be seen in the stock markets, these changes also influence small- to medium-size businesses. Small businesses and their customers will have to pay more to borrow money. Credit cards, lines of credit and commercial loans will all cost more. This increase in the central bank’s lending rate translates into to higher interest rates for all borrowers.
Companies that export products can also be hurt. While these rate changes can strengthen the dollar in foreign markets, they can drive up the price of U.S. products sold in export markets.
The Good News
Not all the news is bad. The projected increase in interest rates is an indication that the U.S. economy is getting stronger. It is a signal that demand is climbing for goods and services. Recent declines in the local and national unemployment figures also reflect this uptick in economic activity.
A higher Federal Funds Rate would tend to slow the recovery. The unemployment rate would not decrease as fast as it otherwise could, and GDP would not grow as fast.
For business owners planning to borrow money, now is the time - before interest rates increase. This may be an incentive for firms that have been putting off major investments that require borrowing money to do so before rates increase.
The greater strength of the U.S. dollar will also allow small businesses to lower the costs of foreign imports of raw materials and finished products. It may provide some relief from growing wage pressures.
Acting now can help a business’s long-term results. Waiting to borrow after interest rates increase could result in companies losing their cost advantage. Borrowing now can keep the cost of capital down and increase profitability.
A businesses that is considering a loan with an interest rate that can be locked in should probably act now. The potential for small business loan rates to increase about a quarter of a percent soon is fairly high.
Dr. Perry Haan is Professor of Marketing and Entrepreneurship, and former Dean of the Business School at Tiffin University. He resides in Rocky River and can be reached at 419-618-2867 or firstname.lastname@example.org.