Inflation has reached record-breaking levels in the past year. With so many supply chain disruptions, this is a predictable if troubling result. In the wake of another inflation spike, the Federal Reserve has increased interest rates, and another increase is expected to follow. What do commercial creditors and debtors need to understand about inflation, interest rates, and the Federal Reserve’s next move?

Why the Fed raised rates

When the Fed raises benchmark borrowing rates, it creates a ripple effect on interest rates throughout consumer and commercial markets. This means interest rates for all types of loans are on the rise. The intended effect is to discourage borrowing and spending and encourage cutting costs and saving. This is a normal response to inflation with one key difference — the amount of the increase. With inflation rates at a 30-year high, rate increases are high to match.

The goal is to slow inflation, and interest rates are the Fed’s primary tool for managing inflationary trends. The consequences of rapid, ongoing inflation are much more severe than the typical short-term effects of higher interest rates. As far as how this affects commercial credit, there’s good and bad news.

The bad news

For companies depending on commercial credit to drive revenue, interest rate increases can pose major problems. When rates discourage borrowing, commercial credit loans are less attractive and fewer companies qualify. As for existing accounts, inflation and higher interest rates increase the possibility of a sharp spike in delinquent accounts. High interest rates make it difficult for some borrowers to repay their debts.

Overall, raising interest rates is not without risk. While it can slow inflation when done strategically, a miscalculation by the Fed could cause serious economic consequences, up to and including recession. Raising benchmark interest rates is not a decision the Fed takes lightly, and given the current severity of inflation, it’s not difficult to understand the Fed’s decision — and it’s not all doom and gloom.

The good news

One of the biggest contributors to today’s inflation problem is supply chain disruption. Because rising interest rates slow spending — particularly for larger investments, such as digital transformation technology — there will be less demand for such high-dollar items. A dip in demand will help mitigate supply chain issues, and back orders will drop, making it easier for companies to fill orders. All of which should drive inflation down and allow the Fed to lower interest rates again. In the end, something like homeostasis will eventually return.

In the short term, there is some good news for commercial credit. The Fed will most likely raise interest rates again in the next few months. Many companies will be more inclined to borrow before rates go up again. This is good for businesses that need to borrow now, and it’s good for creditors that will likely see a drop in new applications when new, higher rates take effect.

Inflation’s ripple effects have serious implications for commercial credit and B2B business, and the Fed’s attempt to curb inflation comes with its own set of problems. Understanding the relationship between inflation and interest rates is the first step to protecting your business from the worst of the consequences.

Need help managing your commercial credit risk? MSCCM financial experts can assist you. Contact us today.