What the Fed Rate Hikes Mean for Small Businesses

After nearly seven years of a zero interest rate, the Federal Reserve has hiked the short-term rate seven times in the last two years, with plans to continue raising the rate through 2019. For small businesses, these rate increases are a double-edged sword. Rising short-term rates are sign of a strong economy, which is great for business. However, higher short-term rates are likely to lead to higher borrowing costs. So, what’s a business owner to do?

The Good News

For now, the economy is firing on all cylinders and growing at a healthy clip, which is why the Fed is raising rates – to keep it from heating up too much and sparking inflation. The Fed wants to keep the economy growing, so it has to be careful not to raise rates too far too fast. It is shooting for a target inflation rate of about 2.25% and it will adjust the short-term rate as needed keep it at or below that rate.

Although the Fed rate has increased nearly 10-fold over two years, its effect on borrowing rates for credit cards, a line of credit or other business loans, has yet to be felt. There tends to be a lag between changes in the Fed rate and borrowing rates, but it may catch up to some degree in 2019.

Right now, small businesses should be taking full advantage of the drivers of economic growth, including record consumer and business confidence, high employment and rising incomes, to expand their offerings and increase revenues. If inflation happens to tick up a little bit, it’s not necessarily a bad thing, because it can push prices for goods and services up, which allows businesses to increase their prices over time. This can help improve margins and cash flow.

Finally, rising rates means more profits for banks, which can translate to more incentives to approve loan requests. Overall, that can lead to a more competitive lending environment, creating more opportunities for small business to access capital.

The Bad News

Borrowing rates for businesses will rise, which will increase costs for new loans an existing variable rate loans and credit cards. Higher borrowing costs will eat into cash flow and profitability. In addition, higher interest rates in general may eventually lead to a pullback in consumer spending. The effect of higher mortgage rates is already being felt in the housing market, which has a multiplier effect on the economy. 

What Should Small Businesses Be Doing Right Now?

Small businesses should always be thinking strategically, regardless of the economic environment. For businesses with expansion plans, now is the perfect time to take advantage of low interest rates and a competitive banking environment. It’s time to tune up your business plan and build that relationship with your business bank. Planning ahead by proactively seeking financing will allow you more time to weigh your options and find the best available deals.

At the same time, businesses need to work on cleaning up their financial house, finding ways to reduce existing debt while improving their credit standing. If the need for financing does arise in the next couple of years, a lower debt-to-equity ratio and a higher business credit score will make it much easier to secure financing at the best available rates.

If your borrowing costs do increase, it will be important to ensure your cash flow management is optimized, especially if your business is subject to swings in revenue. Now is the time to shore up cash management with goal of building up cash on hand.

The Bottom Line

It has been a while since small businesses have had to operate in a rising interest environment, but it doesn’t have to be a zero-sum situation. With the proper planning and strategic thinking, small businesses can take advantage of the growing economy, while minimizing any negative effects higher rates might have.