Interest rate ripple effects

Today the Bank of England increased interest rates by 0.5%. Though expected, the news reflects the Government’s continued focus on tackling the impact of inflation on individuals and businesses.

Having reached a low of 0.25% following the Brexit Referendum, today’s announcement marks the tenth consecutive interest rate rise to a 14-year high of 4%.

Whether such monetary policy will serve its desired purpose remains to be seen.

The economic principle is sound. Interest rate rises discourage consumer spending, reducing demand for goods and services, slowing inflation.

But we live in interesting times.

Despite falling wholesale energy costs, retail prices for consumers and businesses remain high due to the lag in these reductions being realised.

Ultimately, the cost of energy is the prevailing factor contributing to inflation. This requires a specific set of measures for households and businesses. With the cap set to rise again in April, and reduced support announced as part of the latest Energy Bill, there are now fresh calls for the Government to revisit its windfall tax on energy companies. Such calls gathered pace today as Shell announced its profits had doubled to ￡32bn .

On top of the inflation conundrum, consumer demand – while undoubtedly on the up since the start of the pandemic – remains muted due to a combination of factors. So is slowing spending at the moment a good idea? Yes and no.

At the risk of sitting on the economic fence, tackling inflation this way is a mixed blessing. It may well have its intended results in the long-run, but in the short-term, the cost of borrowing continues to rise eroding disposable income of households and profit margins of small businesses.

Meanwhile, business insolvencies reached a 13-year peak in 2022 as government measures introduced during the height of the Covid-19 pandemic ended. According to official figures, total insolvencies were a worrying 57 per cent higher last year than in 2021.

Combined with other challenges facing SMEs – the cost of doing business, reduced consumer spending, labour shortages, import/export costs to name a few – it is time for SMEs to take their fate into their own hands.

This should include reviewing business models, seeking advice, developing new supplier relationships and finding ways to overcome a very real cost of doing business crisis. How does a term loan compare with an overdraft? Can business assets be leveraged more effectively to unlock cashflow? Is there a way to reduce costs by finding new supply chains, domestically or internationally?

On this note, SMEs trading overseas should ensure they have a foreign exchange strategy to offset currency volatility as a recession looms. As the pound reacts to future rate rises and economic indicators, importers and exporters will promptly see profitability impacted. ?

Notwithstanding the glass-half-empty approach indicative of this nation, the picture has undoubtedly improved under the new(ish) government. It now needs to ensure that measures introduced to tackle a specific challenge, don’t cause a chain of events worse than the primary issue.