How could a rate hike affect UK businesses?

The Bank of England (BoE) has been hitting the headlines in recent days, as speculation around when the bank will raise interest rates reverberates through news networks and economists’ Twitter feeds.

UK inflation has been above the bank’s 2% target for five months now, and it’s expected rise well above 4% before the end of spring. As such, the BoE will have to hike rates sometime soon to curb inflationary pressures.

But when will a hike happen? And how could it affect British businesses? We take a look at what a rate rise might mean for UK companies and when the BoE is expected to act.

Consumer spending could fall

When interest rates rise, both the cost of borrowing and the returns on savings go up. That means consumers are likely to borrow less and save more.

Of course, if consumers are saving then they aren’t spending. And if consumers aren’t spending then businesses could see their revenues shrink.

Higher interest rates will also mean that costs on existing debts – including mortgages – will go up, leaving consumers with less disposable income. Once again this could hit consumer spending, especially on luxury goods, so many companies could see business start to slow.

Imports might become cheaper

The pound will likely soar when interest rates go up, as higher rates offer lenders a higher return, which attracts foreign capital and makes the pound a more appealing currency.

A strong pound would mean more buying power overseas and the prices of imports could therefore fall. This would be good news for UK importers, who can turn the strength of the pound into profit.

Sterling could climb particularly sharply against the euro, as the European Central Bank (ECB) isn’t expected to raise rates until 2024. This means that EU imports may be particularly cheap, which once again is great news for businesses that buy EU-made goods to sell in the UK.

Export revenues may shrink

However, it’s not such great news for British producers and exporters. Firstly, cheaper imports could make it easier for items made overseas to undercut British-made products on the UK market.

Secondly, a stronger pound could eat into exporters’ revenues. The higher the GBP exchange rate, the less money exporters will get when they transfer their overseas income into pounds. (It’s worth noting here that a forward contract could help protect profits by securing a fixed exchange rate for up to a year.)

This could exacerbate Brexit-related issues already facing British exporters and producers. Following Britain’s exit from the European Union (EU), UK exports going into the EU are subject to tighter border controls, making the process more costly and time-consuming.

Meanwhile, the UK government recently postponed checks on EU goods entering the UK until mid-2022. The measure is intended to alleviate supply-chain issues, but some have warned it will also dent UK producers’ competitiveness.

Ian Wright, CEO of the Food and Drink Federation, commented:

‘The repeated failure to implement full UK border controls on EU imports since January 1 2021 undermines trust and confidence among businesses. Worse, it actually helps the UK’s competitors. The asymmetric nature of border controls facing exports and imports distorts the market and places many UK producers at a competitive disadvantage with EU producers.’

One positive effect an interest rate rise can have for exporters is to reduce inflation, thereby making exports more competitive. However, there are concerns that a rate hike will have a limited effect on soaring inflation, as many of the underlying causes are set to persist.

In the words of BoE Governor Andrew Bailey:

‘Monetary policy cannot solve supply side shocks. Monetary policy cannot produce computer chips, it cannot produce wind, it cannot produce truck drivers.’

The UK’s economic recovery could falter

Stepping back and looking at the bigger picture, there’s a chance that an interest rate hike could hurt the UK economy – if it comes too soon.

An increase in borrowing costs would add to a number of factors that are set to put a squeeze on the cost of living, including an imminent rise in National Insurance contributions, higher prices, cuts to Universal Credit, and the UK’s energy crisis.

These factors make the UK’s current economic recovery – which seems to be slowing – particularly fragile. Throw in higher borrowing costs and you could see consumer spending slump, export revenues fall, unemployment rise and, before you know it, we’re in another recession.

GBP exchange rates might become volatile

While a rate hike is likely to see the pound strengthen overall, GBP exchange rates could experience some volatility as markets react and reposition following any policy changes. And if there are economic headwinds, this volatility could intensify.

For businesses, currency volatility can create uncertainty and, at worst, eat into profits. That’s why it’s always best to work with a specialist currency partner.

Currencies Direct can offer you a range of tools, such as forward contracts, market orders and options, to help you navigate the ups and downs of the currency market. You’ll also have access to our expert guidance and competitive exchange rates.

It’s also worth considering a forex risk management strategy, which would help make your cash flows more predictable and mitigate the risks to your bottom line.

So, when will the BoE hike rates?

Considering the current economic climate, the BoE faces a challenge. On the one hand, it needs to act to stop inflation overheating and damaging the economy. On the other hand, acting too soon could also damage the economy. Getting the timing right is no mean feat.

Opinions differ on when the BoE will announce an interest rate rise. Before the CPI reading for September, traders priced in a 59% chance of a rate hike in November, but this dropped to 32% after the CPI unexpectedly eased from 3.2% to 3.1%, according to data from CME. The same data puts the probability for a rate hike at 70% in December, going up to 80% in February.

A key factor driving these expectations is the hawkish commentary from some BoE officials. Recently, Governor Bailey was widely quoted as saying the central bank ‘will have to act’ on rising inflation, while a BoE colleague, Michael Saunders, said:

‘I think it is appropriate that the markets have moved to pricing a significantly earlier path of tightening than they did previously’.

Looking at these comments, and how markets have responded, it seems like a rate hike this year is highly likely.

However, there are dissenting voices.

Many analysts have pointed out that Bailey’s comments were more nuanced and less hawkish than initially presented by many news outlets. Bailey actually reiterated his view that higher inflation would be temporary and added a condition to any tightening of policy, saying the BoE would have to act ‘if we see a risk, particularly to medium-term inflation and to medium-term inflation expectations’.

Meanwhile, two of the nine rate-setters in the BoE’s Monetary Policy Committee (MPC), Catherine Mann and Silvana Tenreyro, have expressed their views that a rate hike is not yet necessary.

Mann pointed out that the expectation of a rate hike has already led to an increase in borrowing costs in the financial markets, lessening the need for a rise in interest rates. And Tenreyro has argued that many of the factors pushing up inflation could prove temporary, in which case a rate hike would be ‘self-defeating’. The remaining five members of the MPC have kept fairly quiet in recent weeks.

So while City traders are pricing in the chance of a rate hike at 70% before the end of the year, many analysts believe the BoE will wait until February or March, with multiple hikes to take place throughout 2022. However, a December rate rise isn’t impossible, so it may be prudent to prepare for higher borrowing costs.