Amidst a strengthening labor market, rising economic activity, and a declining unemployment rate, the Federal Open Market Committee (FOMC) decided last month to raise the federal funds rate – the interest rate at which banks and credit unions lend Federal Reserve funds to other banks and credit unions overnight – by a quarter-point, from 1.75 to 2 percent. This is the second increase in 2018, and two more increases were suggested by year’s end.
To the average small business owner, the knee-jerk reaction might be a negative one. After all, interest rates do trickle down, affecting credit card balances, adjustable-rate mortgages, and variable loan rates. But the increase could potentially be good news for small businesses. Higher interest rates amid a strong economy mean more profitable deals for banks, which creates a greater motive to offer more financing options and approve loan requests.
Another potential long-term benefit to higher interest rates is a better cash flow. Because inflation is typically a motivator for rate increases, the cost of goods and services tend to escalate, effectively allowing small businesses to raise prices, improve margins, and enjoy more breathing room.
As with any change in the economy, however, the impact on small businesses could have negative consequences as well. One potential consequence of higher interest rates is the effect on consumerism. Because consumers with credit card debt will be paying higher interest rate charges, they’ll have less disposable income to spend, which could hinder sales and growth of small businesses. Additionally, companies that need to borrow money for growth can potentially incur a higher cost of capital when interest rates go up. This can affect new loans as well as existing loans with floating rates.
Because interest rates have been hovering near zero for the past several years in order to spur the economy, a move in the needle was inevitable, and we are unlikely to see rates that low again anytime soon. With the Federal Reserve’s suggestion of additional increases to come, small businesses that are contemplating applying for loans might want to do so sooner rather than later.