How Inflation And Interest Rate Hikes Hurt Small Business

The Federal Reserve, in its Federal Open Market Committee (FOMC) statement earlier this month, said that inflation remains “elevated, reflecting supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures.”

Russia’s invasion of Ukraine is causing tremendous human and economic hardship there, but domestically, the implications for the U.S. economy are uncertain. The FOMC statement said that in the near 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 businesses owners, according to a recent survey conducted by the U.S. Chamber of Commerce. To cope with inflation, 67% of small businesses have raised prices, according to the study. Another four in ten (41%) report having decreased staff or taken out a loan in the past year (39%) in response to growing inflation pressures.

“Having survived the pandemic, now small business owners are being hit with surging inflation. It’s limiting their purchasing power and forcing small businesses to raise their own prices and absorb higher costs within already thin margins,” said Neil Bradley, chief policy officer at the U.S. Chamber of Commerce.

Costs of materials, inventory, labor, and fuel continue to rise, putting a strain on even profitable businesses.

“There are far more job openings going unfilled today than before the pandemic, despite today’s unemployment rate being higher,” said Fed Chair Pro Tempore Jerome H. Powell. “Record numbers of people are quitting jobs each month, typically to take another job with higher pay. Nominal wages are rising at the fastest pace in decades, with the gains strongest for those at the lower end of the wage distribution.”

Oftentimes, those on the lower end of the wage distribution are workers at the smallest mom-and-pop shops. Thus, wage inflation is hitting the smallest of small businesses significantly.

Further, Powell explained that inflation moved up sharply in the fall, and since the FOMC’s December meeting, the median projection for year-end 2022 jumped from 2.6% to 4.3%.

“In my view… forecasters widely underestimated the severity and persistence of supply-side frictions, which, when combined with strong demand, especially for durable goods, produced surprisingly high inflation,” Powell said in his post FOMC-statement.

The Fed seeks to achieve maximum employment and an inflation rate of 2% over the long term. As a result, the FOMC decided to raise the target range for the federal funds rate to 1/4 to 1/2 percent and anticipates that ongoing increases will be appropriate. The Committee will continue to monitor the implications of the ongoing impact of COVID on public health, labor market conditions, inflation pressures, and financial and international developments.

The need for stable and ongoing financing is something that business owners are going to face for the foreseeable future. The higher inflationary and higher interest rate environment that we find ourselves in today is a challenge for small business owners. Costs keep rising because of ongoing supply chain issues and labor shortages.

Fed rate hikes will, in turn, drive up the cost of borrowing for small businesses. These rates are already well above the benchmark rate for mortgage lending, for example. That could drive the minimum cost of financing to around 9% APR. The new rates are not just applicable to the new loans originated this year; these higher rates will apply to existing loans because most business lenders have floating or variable rate financing products.

SBA products are going to increase in rate as these interest rates rise. Even business owners that are not planning to expand soon, should put themselves ahead of the curve and get approved for a financing option now rather than later.

Women business owners, in particular, should be paying close attention to these economic trends. Earlier this month, Biz2Credit released its annual Women’s Small Business Study. It found that revenues, of female-owned firms dropped 26% in 2021, compared to 2020, and that credit scores also declined. Having lower credit scores can impede securing the lowest interest rates.

Looking to the future, since the Fed has signaled a willingness to continue raising rates, business owners should keep in mind that most small business loans and SBA products are issued at floating rates. They must factor the increased cost of capital into their decision-making process.

While the spread of interest rates can be anywhere from the mid to high single digits up to the double digits, but rates may not be the deciding factor. Instead, for some companies, the most important factor is very often immediate need, including the opportunity cost of losing out on a property or getting inventory at a reasonable price through advance payment. This has become increasingly important at a time when supply chain issues are driving costs of both raw materials and completed goods.

We have known about the change in the interest rate environment since the middle of last year. Borrowing rates were at near zero rates for many years, and low-cost money was flowing to companies for a long time. We have not experienced a significant rate hike pattern since 2018, a pre-pandemic time that feels like ages ago. If small businesses can get fixed rate financing today, they should take advantage of the opportunity since rates will likely continue to climb as the Fed sets policies aimed at slowing inflation.