Reserve Bank increases to interest rates: what it means for your business

Source: Cash Rate Target | RBA

To put this into perspective though, it is worth considering what the cash rate means and what the average official cash rate has been over the past twenty years. I use twenty years as this is a good proxy since Australia’s economy had matured and moved well beyond Paul Keating’s “banana republic” comments of the late 1980s, allowing for the structural reform of the Hawke / Keating governments to have their proper impact.

Since February 2002, the average official cash rate has been 3.35%, with a high during that period of 7.25%. The official cash rate is the base off which the lending banks base the rates they lend to the market. The low is, essentially, the 0.1% rate we had seen from November 2020 until April 2022. As economists had been saying, there had never been a better time to borrow. 

Now, however, the market has changed. The real risk here is that people have grown accustomed to low-interest rates and what they may now see is their cost of borrowing genuinely double. Needless to say, for businesses, this significantly impacts decision-making, particularly when it comes to making investments, funding expansion, hiring more staff, etc. 

As we head into the second half of the year, the RBA cash rate is forecast to move substantially higher from its current 1.35%, with one of the ‘big four’ banks forecasting a cash rate of in excess of 3%. The other three banks currently expect this rate to hit 2.6% by the year’s end. This has substantial implications for all businesses and households throughout Australia as this is roughly, at least, a doubling of the current cash rate. 

If you are a business leader, here are some insights on how rising cash rates might affect your business and tips on what to do to survive these market challenges.

Five ways the RBA interest rate rises will affect businesses

1. Increased cost of borrowing

Banks and other lenders will increase interest rates on business loans. Profits may fall as a larger portion of earnings is directed towards interest payments. Business growth may suffer as a result of deferred projects and postponed expansion plans, both previously funded by low-interest business loans.

2. Likely wage rises

Unions and individual employees are more likely to push for wage rises to help with the increased cost of mortgages and other expenses, adding to business costs. Labor leader Anthony Albanese said during the election campaign that he supported a 5.1% increase to the minimum wage, and the minimum wage was in fact increased by 5.2% from 1st July 2022.

3. Increase in other business expenses

Interest rate increases are likely to be reflected in the cost of all business expenses, as prices inevitably rise to cover higher costs throughout the economy.  

4. Squeeze on both customers and suppliers

Sales may fall as customers reassess their budgets in the face of increased payments on mortgages, personal loans and car loans. Business-to-business debtors may try to stretch their credit terms, impacting their creditors’ cash flow.

Suppliers, on the other hand, may try to shorten their own payment terms, creating a cash flow double whammy. Fierce competition in the already disrupted supply chain is likely to get worse, and businesses may find it necessary to accede to suppliers’ demands for earlier payment in order to secure vital inventory.  

5. Increased interest income could reduce capital expenditure 

While the increased cost of borrowing could reduce business capital expenditure, additional interest income for those businesses in the fortunate position of having cash investments could have the same effect. If money deposited in a bank account gives a higher rate of return than expenditure on new premises or equipment, cash is more likely to stay in the bank. Once again, projects and expansion are deferred, meaning that opportunities may be missed.

What businesses can do to survive a period of high inflation and rate rises

Whenever the RBA interest rate is increasing, it’s a given that inflation is also high, since interest rate rises are a lever used by central banks to curb inflation. Here are some ways to shore up your bottom line during these challenging times.

• Reassess your business plan

It’s worthwhile revisiting your business strategy to make sure that it aligns with current conditions and is sufficiently flexible to sustain shocks. You may need to reconsider expansion plans in the short term.

• Examine financing options

Now is also the time to take a hard look at the types and levels of your existing business debt. Are you over-extended? Can you reduce costs by refinancing? Should you convert variable rate business loans to a fixed rate?  Do you have enough available capital to support your cash flow? 

• Monitor your business partners

Your suppliers and customers are your key partners, and if they struggle your supply chain may be disrupted or your sales may suffer and bad debts increase. You may be able to secure your financial position with bulk purchases, fixed price contracts and credit insurance, but bear in mind that your partners are going through the same challenges as you and are having to make the same choices.

• Hedge foreign currency transactions

An increase in Australian interest rates may lift the value of the Australian dollar, since it becomes more attractive to foreign investors. A lift in the local dollar’s value is bad news for any business making export sales in a foreign currency, or paying for imports in Australian dollars. These transactions can be hedged via forward exchange contracts or options, or by matching the purchase and resale currencies of finished goods. 

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