Why SMEs should listen to Central Banks

The announcements made by economists at central banks can sometimes seem a world away from the day-to-day challenges of running an SME. Ultimately, it’s sensible to follow their impact on the institutions that manage our money, comments Rhys Herbert, Senior Economist, Commercial Banking, Lloyds Bank

Take an interest

Decisions about interest rates might be the biggest way central banks can directly impact SMEs. When the Bank of England raises the base rate of interest – the rate it charges commercial banks when it lends them money – then commercial banks tend to pass that on to business customers by charging them more to borrow money.
And decisions made by central banks in the US and Europe can have a big influence on the Bank of England.

In the UK, interest rates are currently very low, but that leaves small businesses exposed to rate rises. Not only can an interest rate rise mean firms pay more on their borrowings, it can mean homeowners pay more on their mortgage, so they have less disposable income to spend as consumers.
Assuming an orderly Brexit, interest rates are set to rise – it’s a question of when, not if.
So, listening to the noises coming from central banks can give you a clue as to when, and by how much, rates will rise. This gives you the opportunity to prepare, perhaps by taking measures to manage cash flow or fixing the rates of any loans or mortgages you hold. Let’s take a look at the most recent announcements by central banks around the world.

American influence

In the US, the first half of 2019 has seen a big change in interest rate expectations.
Late last year, markets were still expecting further interest rate rises from the Federal Reserve, whereas now they are expecting significant cuts.

The Fed’s message has changed markedly this year. Back in December, at the same time as hiking interest rates for the fourth time in 2018, the Fed’s policymaking committee pointed to the likelihood of “some further gradual increases” in interest rates in the near future.
Six weeks later, it adjusted its guidance to say it now intended to be patient before making any further rate changes, an indication that rates were now likely to be unchanged for several months.
Then on 19th June, it dropped “patient” in favour of a comment that it will “act as appropriate to sustain the expansion”.

So, in less than six months it has moved from a bias for higher rates to one for lower rates.
Markets see this as the ‘green light’ for a rate cut. A quarter point cut at the Fed’s next policy meeting in late July is seen as a near certainty, while the probability of a larger move of half a per cent cut is now unlikely after Friday’s reports of strong US employment growth.
Most recently, the European Central Bank’s president Mario Draghi has also been talking about reducing rates further unless economic conditions improve.

For UK businesses, the big question is: where does this leave the Bank of England?

Bucking the trend?

With most of the major central banks turning against increasing rates, its message that interest rates will eventually probably need to go up makes it look like an outlier.
However, when setting policy, central banks need to weigh up both the international picture and domestic circumstances when deciding what action is best for their own economy. That’s why the Norwegian central bank raised interest rates on 20th June.
There have been plenty of previous examples of when UK interest rates have bucked the trend. Will this be another of those occasions?

In the near term, Brexit uncertainty means that this will not be tested as Bank policymakers have again confirmed their inclination to sit on their hands until we have more clarity.
However, a resolution or even substantial progress on Brexit before year end may mean that the Bank will still need to weigh up conflicting international and domestic pressures.

What next?

Before the most recent Bank of England update, comments from some on the Bank’s Monetary Policy Committee had highlighted the likelihood of an interest rate rise and the Committee maintained its bias in favour of higher interest rates.
That was because unemployment is currently very low, which should push up wages, causing inflation.

Increasing interest rates is one of the tools central banks can use to stop prices rising – when interest rates are higher, people tend to prioritise saving over spending, slowing down the economy and causing prices to fall.

That said, when Governor Carney answered questions from MPs on the Commons Treasury committee recently, he said a no-deal Brexit would probably require economic stimulus.
That could mean cutting interest rates to try and stimulate investment.

So, we can see that there are many factors influencing what may happen next to interest rates.
At times like these, it’s worth SMEs keeping a close eye on what the central banks are saying so they can plan ahead.

After all, forewarned is forearmed.