Interest Rates

Published: 14 January 2023

Last week I wrote about interest rates: you probably missed it as it was within an article on Private Equity; at the start of which I encouraged you to read no further if PE was not your thing.

Interest rates though have a bearing on all of us (Not just those of us contemplating the sale of our business, which is what I was referring to in the PE article: the theme of that article being that interest rates are in my opinion, and the opinion of others going to peak at about 4.5%, and that will help buyers of companies better budget for the return on investment, since they will more accurately know the cost of borrowing).

Inflation has, as we all know been a huge danger to the economy. At the time of writing, inflation is 9.3%, and the next update will be in 18 January 2023. I confess I have no idea whether this will increase or decrease, but frankly care more what the direction of travel will be over the next 12 months, which has to be downwards.

 Let’s for a minute imagine that you are the Prime Minister: you are going to give five pledges, would you make sure that you were pretty confident about the first on your list? I know I would, and to recap Rishi Sunak’s first on his list was, earlier this month, to halve inflation. He therefore has it in his mind as an odds-on certainty. It is his Constitution Hill to win the Champion Hurdle at Cheltenham (should he enter –‘He’ being Constitution Hill, though Rishi has a good build for a jockey).

This means, that after the next few months there will be no need for interest rates to increase.

Moreover, whilst not officially and technically in a recession most of us believe that the economy is far from raging ahead, and believe it is in decline. Given that there are lags from the effect of interest rate increase, I would hope that the MPC might not be too aggressive in future increases, lest they go too far.

The BoE measure money supply: specifically, growth in the money supply, which peaked in early 2021 at a little over 15%. This is a marker of inflation, and interest rate increases follow as we saw later in 2021. Given that the annual growth in money supply is now down to its levels throughout 2013 to 2016, assuming it stays there, the BoE should see that as an indication not to keep increasing interest rates, and then eventually reduce them: certainly not increase.

Then there is a raft of other indicators.

·      Companies are being reticent to offer inflation level pay rises… even the unions are starting to realise they cannot expect the awards they were hoping for.

·      Energy costs have hopefully peaked… at least for households. As an aside there are dangerously high levels still to impact on some businesses, since some will have hedged for several years, and so the effects of increased costs will still be unwinding for some.

·      But to a large extent the effects of energy increase have been baked into the inflation rate and so if costs fall inflation will drop markedly.

·      Finally, mortgage approvals are plummeting. At the end of 2022 they were just 30% of the level they had been throughout Spring and Summer 2022. Most professionals in the property sector believe that house prices will fall in 2023… by around 8%.

What do we do with all this? Well, the start of the year is when business owners use their new budgets… that could be for the calendar years 2023, or (since many companies have a March year end) for the 12 months beginning 1 April 2023.

If you have borrowing costs, or are considering investment in CAPEX, or other purpose, perhaps you should use a base rate of 4-4.5% plus bank margin. As regards price increases, that will depend on the ability to raise those with customers.

Supply into retailers aside with which pricing is a notoriously difficult issue, most businesses expect to have increases from their suppliers. However, even major retailers know that they will have to accept higher costs from suppliers. Food inflation for example is currently at variously, 13.3%, 14.3%, 16.5% depending on whom you ask and the precise period (the last two are from the ONS). Food producers, fresh or processed should not be working on the status quo.

Wage increases, seem to be averaging circa 6%. Again, though that varies depending on how exposed the workforce is to increases in the living wage. Although in practice all businesses are exposed, since increases in the lower level, if not applied across the whole workforce narrows differentials and create a risk of employees moving to competitors. It would be though a brave choice for an employee to risk job security by moving: thorough due diligence of the new employer would be wise.

Finally, business risk: I had a coffee with a trusted insolvency practitioner before Christmas, and I am minded to agree with his view that COVID, followed by the unwinding of government support, had the effect of clearing out most struggling businesses. Economic times are clearly not the best: you only need to try to take a train, do a weekly shop, look at your mortgage cost, or even try to hire a barrister to see that. But, and hopefully, the good news is that better times are on the way.