What interest rates mean for your small business

In June, the Bank of England increased the base rate to 5%, in its latest attempt to get UK inflation under control.

In fact, rates have risen sharply in a series of 13 hikes from record lows of 0.1% in December 2021.

Here, we explain what this means for small business traders and what you should do if your costs increase. 

What does this mean for small business traders?

The consequences of rate rises on your  small businesses could be severe. Key areas of concern include higher costs of borrowing, more expensive supply chain costs, and less consumer spending.

Reduced spending

High inflation means that everything gets more expensive. With core costs including energy bills, food prices and rents all soaring, the average consumer has far less disposable cash than they did a year ago. For small businesses, this may lead to lower sales and downwards pressure on prices.

High interest rates are designed to curb inflation, but the knock-on effect on mortgages may worsen the cost-of-living crisis. As millions more homeowners find monthly payments increasing by hundreds of pounds at renewal, there will be many people who have to tighten their belts. 

Equally, those with other debts will be spending more each month to service them. This may force them to curb spending in other areas.

When consumers start to spend less on non-essential goods, you tend to see fewer startups, more firms closing down, and a halt to small business growth.

The Federation of Small Business’ national chair, Martin McTague explained: ‘While higher interest rates are a tool to control inflation, the weight of escalating costs means consumers have less disposable income to circulate in the economy. When the money in their pockets is worth less, the upshot is reduced sales for businesses.”

What to do: SMEs should carry out careful cashflow forecasting to see how a drop in consumer spending will impact their company. This will have knock-on impacts on everything from required staffing levels to stock levels, and businesses must plan accordingly.

House prices impact

Higher interest rates mean that buyers’ affordability levels drop. There’s already evidence that this is making potential first-time buyers and those moving up the ladder nervous. If high rates persist, banks are likely to continue to tighten lending criteria and would-be homeowners may have to reevaluate whether they can afford to move. 

This could be good news for some small businesses, for instance those who work in construction and home improvement. People may look to extend or improve their existing properties rather than trying to buy a bigger house. However, those involved with new builds may face troubles if buyers are unable or unwilling to get the mortgages they need to purchase their first home.

Some businesses may see their rents rise on office premises, which could squeeze bottom lines further.

Higher borrowing costs

It’s not just consumers struggling with more expensive debts due to high rates. SMEs will also face a higher cost of borrowing for their business loans.

Any businesses with variable rate loans will have already seen interest payments rocket, while those looking to take out new fixed deals will find that the rates offered are prohibitive. In fact, the BoE’s latest statistics show that the effective interest rate on new loans to SMEs rose from 6.52% in April to 6.86% in May, compared to 2.51% in December 2021.

The British Chamber of Commerce’s head of research, David Bharier, said: “While inflation is still the top concern for businesses, interest rate rises are now causing worry for a rapidly growing number of firms with soaring borrowing costs. Businesses will need clarity on the direction of further changes.”

McTague added: “High Street retailers, start-ups, local bakeries, and tech innovators alike are all feeling the pinch. As the weight on the small business and self-employed community grows heavier, we must strike a delicate balance.”

What to do: SME owners should look at the terms and conditions of existing loans to see when rate rises might affect them. Shopping around for the best deals for future credit has never been more important. Fixed rates may not always be the best on offer, but they could provide helpful certainty in a rising rate environment.

Higher supply chain costs

Even if your firm is relatively unaffected by rate rises, your suppliers may have to put their prices up. This may mean that you pay far more than expected for the goods and services you need to run your business. 

What to do: You should identify your critical suppliers now, and forecast to see how costs increasing will impact you. Agreeing on contracts before the next rate rise could save you money, as could buying in bulk and diversifying your supply chain.

How high could rates go?

Upwards pressure on interest rates is set to continue, with many economists forecasting that the BoE will announce 5.5% rates next month. 

However, interest rates are predicted to rise less sharply in the UK after inflation dropped more than expected in June. 

Experts say the BoE is under less pressure to act after inflation slowed to 7.9% in June, down from 8.7% in May. 

The next base rate meeting will be on 3 August 2023.

• Find out more: inflation falls sharply to 7.9%