Business Borrowing Cost Rises: How Will It Affect UK Companies?

November 14, 2022

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Business in the UK is striving to develop, but now, in difficult economic conditions, it simply needs to survive. This requires financial assistance, namely loans. Rising interest rates and inflation significantly complicate the situation of indebted companies, and sometimes the new rates make the inflow of funds inaccessible. 

It was recently reported that the Bank of England raised the base rate to 3% in an attempt to reduce inflation in the UK. The latest increase did not come as a surprise, as last month the head of the Bank of England, Andrew Bailey, warned that a new rate hike could be more than the previous increase of 0.5 percentage points to 2.25%. A senior official of the British Chamber of Commerce (BCC) said that it would be a "further headache" for business: higher rates mean higher borrowing costs. 

Let's take a look at the economy today and experts' forecasts and find out how it will affect companies in the UK.

The Bank of England Warns of a Long Recession

We have witnessed the biggest interest rate increase in recent decades. The Bank of England has taken such measures as it tries to mitigate the current cost-of-living crisis and cope with inflation. Moreover, the regulator warns of the possibility of a prolonged recession in the UK. According to Bank’s estimates, this could be the longest recession in the last century.

The majority of the members of the Bank's Monetary Policy Committee, 7 out of 9, voted in favour of raising the base interest rate. It rose from 2.25% to 3%, which is the highest level since 2008. The last time such a sharp increase took place was in 1989. This is the 8th time the Bank has raised interest rates. Compared to the previous year, this figure is 0.1% higher. 

According to the Bank's analyses based on current market forecasts, the UK economy may be in a negative growth phase for the next eight quarters. This would be the longest period of economic decline that the country has seen in the last 100 years. 

UK Economic Forecasts in Figures 

The good news is that a milder recession is expected in comparison to previous times. The gross domestic product (GDP) is forecasted to decrease by 2.9%, which is significantly less than the 6.3% drop that the economy experienced during the financial crisis in 2008. As for other statistics, the Bank predicted an inflation rate of about 11% at the end of this year, which will be the peak. At the same time, the unemployment rate may reach 6.4% by the end of 2025. 

Several measures were taken to reduce the cost of borrowing. The Bank of England bought bonds, Kwasi Kwarteng's mini-budget was postponed and the Prime Minister and Chancellor were changed. Thanks to this, markets predict an increase by one percentage point. 

Globally, rates have been rising significantly, but now the speed is not that high. For example, the US Federal Reserve last week raised rates by another 0.75 percentage points. Despite the likelihood that rates will be raised further, the US regulator assumes that they will be lower, which signals relative stabilisation. Another example is the Bank of Canada, which raised the rate by 0.5 pp, even though, according to forecasts, it should have been by 0.75 pp.

How Does Raising Interest Rates Help Reduce Inflation?

The Bank raises rates to combat price increases known as inflation. Prices have been rising rapidly around the world, as restrictions on Covid have been mitigated and consumers are spending more. Many firms are having trouble getting enough items to sell. And as more and more buyers chase too few goods, prices have risen. 

High-interest rates help control inflation by making it more expensive to borrow money. This encourages people to save more, and borrow and spend less. Yet, this is a complex balancing act, since the Bank doesn’t want to slow down the economy too much.

Small Businesses in Rising Borrowing Costs Period

British businesses are already suffering from soaring energy prices and inflation. Now higher borrowing costs are exacerbating the situation. Since the growth of small businesses often depends on external financing and investments, the increase in the cost of borrowing makes it difficult for small businesses to accumulate the capital they need.David Barrier, head of research at BCC, said the interest rate hike was a very tough tool to control inflation, which was largely the result of global factors including supply chain disruption. He said it was another piece of bad news for businesses that are trapped between rising prices for raw materials, energy, and borrowing, and weakening consumer demand. 

A senior policy adviser at the Federation of Small Businesses, Daryn Park, shared his concerns that small companies would be unable to access loans in case they need short-term cash. With a 3% rate it is still possible, but “if interest rates hit 6%, it will start to price out a lot of businesses,” he stated. What’s more, according to a poll carried out by the Federation of Small Businesses, about half of small and medium-sized businesses complained that the pricing and availability of loans were poor.

From what we have seen so far, higher costs and higher interest rates mean that consumers have less disposable income, which leads to them spending less. It affects businesses’ revenue, adding pressure to rising equipment, materials, and transportation costs.

What Should Small Businesses Do?

If you are the owner of a small or medium-sized business, now your most valuable asset is the flow of funds. High-interest rates increase your variable expenses, for example, using a credit card becomes unprofitable or even too expensive, and it becomes more difficult to save funds.

What can you do:

1) Analyse offers from banks that are on the market. Look for an alternative to your current credit card. Perhaps the source of financing will be a fixed-rate loan.

2) Avoid non-accredited banking institutions and micro-loans, as the low rate hides side costs; for example, insurance and so on.

3) Be aware of the risks of excessive borrowing. If you take out too large a loan with a floating (changing) interest rate, in the end, you risk paying off only the interest, and not the balance itself. Try to avoid this.4) Pay attention to accounting. In times of turbulence and decline in the UK economy, businesses should remain transparent and have all their financial reports in order. You can automate tax payments and reporting to spare time for other crucial business decisions. 

With the latter, the Payrow platform can become your reliable assistant. We’ve been helping startups, online companies, and small businesses to easily process orders, create invoices, and make payment management simple. Our highly secure services help maintain accounting and optimise financial flows. Use Payrow automation tools to speed up and simplify calculating and paying taxes. We provide 24/7 support and advise our customers on the first request. Therefore, if any questions arise, platform users can contact experts and get individual support. Make running your business simple and sustainable even in difficult times with Payrow.