Implications of Rising Interest Rates

by Craig Anthony

3 min read

As the economy expands and companies and consumers keep on spending, your own business likely responds in turn thanks to sustained client demands for your professional or field services. On the flip side, uncontrolled economic and business growth can eventually overheat and cause inflation, increasing purchasing costs and depressing market activities and creating a bad situation for everyone. In Canada, the task of monitoring economic developments and managing future inflation resides within the Bank of Canada, the entity responsible for keeping the economy on a healthy growth path through monetary policies, including raising interest rates when needed. Understanding the implications of rising interest rates can help you make the best of an otherwise unfavorable interest-rate environment.

Impact of Rising Interest Rates

Rising interest rates can have a widespread economic influence across industries in the economy, and you may feel that with your own business at some point. It all starts with the Bank of Canada when it raises its target for the overnight rate, also known as the key policy interest rate. The financial markets use this rate for one-day or overnight loans between financial institutions. When a bank’s short-term borrowing costs increase, it often subsequently charges more for business and consumer services. A bank may also decide to issue fewer loans to prevent borrowing from other banks to cover temporary cash shortfalls when interest rates rise. With fewer available loans that cost more than usual, both businesses and consumers may feel more constrained with financial resources and decrease spending as a result. You want to be aware of such issues with your own business, because with fewer buyers, you likely generate less sales, which in turn can make it necessary to scale back operations and downsize your workforce. If unemployment begins to rise, consumer spending can further shrink, creating a cycle of economic slowdown. Rising interest rates serve as a necessary tool to cool down an overly expanded economy with potentially damaging inflation. Absent the tighter monetary policy, purchasing power often diminishes.

Monetary Purchasing Power

It may seem counter-intuitive to think increased economic activities can lead to the loss of monetary purchasing power, but when the total goods and services output grows at a rate below the pace of money and credit supplies, prices on those products may rise over time, thanks to loose and accommodating low-rate policies that spur the onset of inflation. If you must spend more today to buy fewer goods than yesterday, you know monetary purchasing power is waning. Besides decreasing customer spending, this inflation also increases business costs, which can further disrupt economic activities.

Capitalizing on Rising Interest Rates

If you pay attention to interest-rate changes, you can overcome the negative effects caused by rising interest rates and even benefit from the supposedly unfavorable interest-rate environment. For example, if the Bank of Canada indicates potential rate hikes in the near future, you may consider raising some capital earlier by borrowing at lower rates today to prepare for planned future business expansions. Knowing that in periods of rising interest rates demands for your services may dip when clients have less to spend can help you focus on paring down operations today by reducing the costs of the services you offer. Later, you can use this leverage to make your services more affordable to clients while others struggle with less demand and rising services costs and prices. This forethought might even allow you to drive out some competitors and come out stronger from the rising interest rates. By understanding the implications of rising interest rates and watching when rate changes may be on the way, you can make certain business adjustments beforehand. This helps you prepare for potential negative changes in both the general financial outlook and your own business markets.

References & Resources

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