After a decade of historically cheap borrowing costs, businesses are struggling to adjust to the Bank of England’s decision to increase interest rates. RSM’s Brexit Monitor shows 39 per cent of middle market businesses think the cost of finance has increased as a result of the UK’s decision to leave the EU, with 31 per cent saying the higher costs are worse than they had expected. As this was the second rate rise in a decade, it’s understandable that businesses are nervous. But it’s also important to keep a sense of perspective.
In truth, the BofE’s decision in August to increase the base rate of interest from 0.5 per cent to 0.75 per cent was long overdue. Since 2009, borrowing costs have been artificially nailed to the floor, with interest rates at the lowest level since records began in the 16th century. While this was a boon for businesses, mortgage owners and consumers, it also had the potential to create a precarious economic position.
Ultimately, cheap borrowing rates cause dangerous asset bubbles that, when left unchecked, eventually pop. As we’ve already seen from the 2008 global financial crash, when asset bubbles burst – in property, commodities or the stock market – the economy does too. In this context, interest rate rises become an important economic lever – a vital safety valve that helps air escape from an overinflated market, easing the likelihood of a pernicious financial downturn.
It’s also important to remember that Brexit is only one factor behind the increased borrowing costs. The continued recovery of the global economy, particularly in US, has also pushed up inflation, and prompted investors to demand higher returns on US Treasury bonds and gilts. This is much more likely to drive up the cost of finance on UK shores than the 0.25 per cent increase in the BofE’s base rate.
In many respects, the BofE’s actions have served as a useful reminder of market dynamics: interest rates that go down must eventually go back up. Mark Carney, governor of the BofE, has already hinted at further rate rises to come. And although he’s said increases will be ‘limited and gradual’, it’s clear this is the beginning of the end of ultra-cheap borrowing. Businesses should heed the warning, and take proactive steps to adjust to this new normal.
Today, one of the most important steps you can take to protect your position is to avoid locking your business into long and risky repayment profiles that will quickly become unaffordable if current projections turn out to be inaccurate. Give yourself plenty of headroom, use robust financial modelling techniques and set contingency plans for the unexpected.
Those with long memories will remember that these are the standard steps businesses would have taken 15 years ago, when interest rate fluctuations every six months were the norm. In other words, don’t let a decade of cheap borrowing cause you to forget the basic fundamentals of business planning.