Inflation appears to be cooling: What does it mean for small business owners?

Paul Northway

Guest Columnist

July 26, 2023

The Consumer Price Index (CPI) rose 0.2% in June and 3% year-over-year – which is the slowest pace in more than two years.

Excluding food and energy, the core CPI also rose 0.2% in June and 4.8% from this time last year – marking the slowest pace of ascent since the second half of 2021.

Keep in mind, however, core consumer prices remain more than double the Federal Reserve’s intended target of 2%.

The Federal Reserve’s aggressive battle to curb inflation has resulted in U.S. small businesses paying the most for loans in 16 years, as borrowing costs have skyrocketed.

The average rate paid on short-term loans for small businesses shot up to 9.2% in June, up 1.4 percentage points from May’s reading – marking the largest increase in short-term borrowing costs since 2006, this according to data from the National Federation of Independent Business.

The surging cost of borrowing is by design as the Fed has tried to tighten credit conditions with 500 basis points worth of interest rate hikes since March 2022.

The recent improvement in the inflation outlook has meant the credit crunch for the small business sector has yet to materialize in earnest.

Most economists will warn of a potential lag in the effects of aggressive rate hikes on credit availability.

Another factor in play is the banking industry turmoil unleashed by the collapse of Silicon Valley Bank and two other large U.S. banks earlier this year.

Banks across the country are more focused on liquidity and appear to be growing more conservative with respect to approving loans.

The July increase was a given.

The real debate is what it would take to prompt another rate hike in September or in the fall.

According to Federal Reserve Governor Christopher Waller, the central bank will potentially need to raise rates twice more this year, although cooler inflation data could mitigate the need for a second hike.

Speaking at a Money Marketeers Dinner in New York recently, Waller said, “I see two more 25 basis point hikes in the target range over the four remaining meetings this year as necessary to keep inflation moving toward our target.”

The current Fed Funds target range is 5% to 5.25%.

The Fed Funds rate is what banks charge each other for overnight funds.

It is the benchmark banks use to set the Prime rate, which is used to price small business loans.

The mean projection for the year-end 2023 rate is now 5.6% and to trend around 4.75% in 2024 and 3.50% in 2025.

The reality is the cost of borrowing money is going to stay elevated over the next few years.

The stock market is signaling a soft landing, while the bond market is unequivocally predicting a recession.

Similarly, manufacturing has been in a recession for close to a year, but services are doing fine. 

The sentiment of CEOs across the country is the labor market will defy expectations and remain largely afloat.

We are most likely going to experience a mild recession – one that is “short and shallow.”

There are two battles taking place today – the Fed’s war on inflation and the overall war on talent.

Because of this, small business owners can expect to continue to pay more for borrowing money as well as acquiring/retaining talent.

Paul Northway is the president and CEO of American National Bank Fox Cities.