When rates change, business decisions follow

When interest rates move, most headlines focus on the obvious effects on borrowing costs and the interest paid on deposits. However, for many business leaders, the bigger impact is on timing.

“Rising rates tend to cause business owners to delay decisions to acquire a company, invest in additional equipment, hire employees and other initiatives that help drive the economy,” explained Sean Kelly, a commercial banker with BOK Financial®. Meanwhile, lower interest rates tend to encourage business leaders to invest in the growth of their companies, which in turn spurs economic activity.

That’s not to say that all business leaders delay—or accelerate—decisions or processes in response to rate-changes. In practice, responses to rate changes tend to vary widely across industries and businesses. Companies with strong cash reserves or fixed-rate debt may see little immediate impact, while businesses that rely more heavily on short-term financing often feel changes more quickly, according to Kelly.

Even within the same market, some business leaders may move forward with investments while others choose to wait due to rising rates or economic uncertainty. That uneven response can make the effects of rate changes hard for business leaders to predict.

Moreover, even if business leaders don’t change course themselves, their businesses may still be indirectly affected by rate changes. Kelly gave the hypothetical example of a local developer delaying a project because of higher rates and economic uncertainty. “It can impact all parties involved like architects, engineers, contractors, law firms and so on,” he said.

It’s this indirect impact of rate changes that can be the hardest for business leaders to handle, rather than the more obvious effects of rate changes, which can be anticipated and accounted for. “Most businesses will adjust their budget to account for rising or falling interest rates,” Kelly explained.

Due to this cascading nature of direct and indirect effects, it’s important for business leaders to be aware of potential monetary policy changes and be ready for them, even if they don’t anticipate any disruptions to their cash flow or day-to-day operations.

What to know when rates are rising

When inflation is rising, the Federal Reserve may decide to raise the Federal Funds rate to slow the U.S. economy, which theoretically in turn should bring down inflation. When this happens, consumers and businesses also pay higher interest rates on the short-term debt they have.

In a higher-rate environment, companies tend to be more selective in how they use capital and having easily accessible cash on hand may become more important than investing in growth. As Kelly explained, “It can impact a company’s willingness to use their floating-rate line of credit unless absolutely necessary and delay making strategic investments in their business.”

These shifts in priority may not reflect immediate financial strain on a business. Instead, they point to a more cautious pace, where companies prioritize flexibility over speed.

What to know when rates are falling

Inversely, the Fed may decide to lower the Federal Funds rate when the U.S. economy is slowing, so that the economy doesn’t slow too much, leading to a recession. Other times, even if economic growth is steady, the Fed may decide to lower the Federal Funds rate simply to get it to a more “neutral” level, if the current rate is perceived as too high. When the Federal Fund rate falls, consumers and businesses accordingly pay lower interest rates on the short-term debt they have.

Accordingly, in a falling-rate environment, companies that took on debt when rates are higher may choose to refinance. Meanwhile, as the cost of borrowing becomes cheaper, business leaders may choose to utilize their lines of credit more. This may result in moving some decisions or projects that were on the back burner to the front.

At the same time, companies may reassess how they manage liquidity, according to Kelly. “Deposit clients might lock in longer term rates if rates are expected to fall,” he noted. However, for businesses where interest income is only a small portion of their annual net income, how much they’re earning on deposits may be less important than the bigger-picture effects of lower rates.

The bottom line

And so, for most businesses, the more material impact of rate changes shows up in how and when decisions get made. Even when cash flow remains steady, the timing of investments, hiring and expansion can shift in meaningful ways.

Learn more about what’s ahead for interest rates and the overall economy on BOK Financial’s Business and Commercial Insights page.