International Policy Digest

Federal Reserve
Sponsored Content /22 Dec 2016

What Will a Hike in Interest Rates Mean for Businesses?

In the volatile and complex world of macroeconomics, interest rates remain a central point of debate and controversy.

On Dec 14, the Federal Reserve decided to increase the rate of interest from 0.5% to 0.75%, a slight increase designed to reduce borrowing and the total amount in circulation. What was perhaps more interesting is that the Fed has announced two, maybe three, more hikes in 2017.

“The Fed’s decision to raise interest rates for only the second time in a decade on Wednesday came as a shock to no one, with markets having almost entirely priced the decision in prior to the event,” said Craig Erlam, senior market analyst at Oanda. “Despite the Fed signaling a desire to raise interest rates at a faster pace, there was no panic in the markets which shows the level of confidence investors have in the economy to handle it. Rate hikes are finally seen as a positive once again rather than something that’s going to kill any rallies,” he added.

Many analysts have put this down to a full labor market and several positive index reports that have posted strong figures.

How will interest rate hikes impact businesses?

Of course, the issue with quantitative easing and artificially low-interest rates is that they simply support and uphold an ailing economy, rather than sustaining any form of sustainable growth. This makes the timing of interest rate hikes extremely difficult, particularly as many of the immediate consequences can reverse some of the burgeoning growth trends that prompted the increase in the first place.

With this in mind, the question that remains is how interest rate hikes in the U.S. (and potentially the UK) will impact on businesses and share prices?

One of the key areas of concern is business confidence, which has remained robust (particularly among smaller ventures) throughout a tumultuous 2016. The issue here is that increased interest rates often reduce both business and consumer confidence levels while discouraging spending and hiking the cost of borrowing and reinvestment. This can lead to a stagnation of the small business market, which in turn limits what has emerged as a key driver of growth in the Western world.

Such a scenario would almost certainly see the interest rate lowered again in the long-term unless the Fed and the BoE were happy with minimal growth and increased levels of risk-aversion.

Then we come to the impact of rising interest rates and currency, which impact both businesses and the financial markets. Essentially, a higher interest rate will increase the value of the dollar (or the pound), thanks to increasingly hot money flows from overseas. More specifically, higher interest rates place a greater emphasis on imports rather than exports, while tending to reduce the level of aggregate demand that exists within an economy. As exports become less competitive, business in certain sectors can suffer both in terms of demand and their bottom line profitability.

From an investor perspective, a hike in interest rates tends to represent good news for those who deal in high-risk derivatives, such as currency. After all, not only do interest rates increase the strength and underlying value of a strong currency such as the dollar or the pound, but they also increase the cost of secure and lower-risk vehicles such as bonds. This is an important consideration, particularly for those who make their primary living out of financial trading and often use interest rates as an influential, economic indicator.

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