The Implications of Lower Interest Rates on Small-Scale Enterprises
The Federal Reserve's Federal Open Market Committee (FOMC) decided to decrease interest rates once more on December 18, dropping the federal funds rate target range by 0.25% (or 25 basis points) to a range of 4.25% to 4.5%.
According to the committee, economic activity has persisted at a strong pace, and while labor market conditions have somewhat improved, unemployment levels have risen, although they still remain low. Significantly, the economy has made strides towards reaching the Federal Reserve's 2% long-term inflation target, yet inflation remains somewhat inflated.
With an uncertain economic climate ahead, the FOMC is mindful of the risks to both sides of its dual mandate of full employment and the 2% target.
The main reason for the Fed's decision to lower interest rates is the improvement in overall inflation figures. There was widespread speculation in the markets about the FOMC announcing an interest rate cut, and this expectation was realized. Furthermore, the previous month's Jobs Report was quite weak, which further justified the third consecutive rate cut.
Related: *Why Lower Rates by the Fed Will Enhance Small Business Profits*
In determining the extent and timing of future adjustments to the federal funds rate target range, the Fed has highlighted its intention to analyze incoming data, the evolving outlook, and the balance of risks. Since September, the federal funds rate has decreased by a full percentage point from its peak. This represents a significant decline in such a short period. The FOMC should carefully consider the potential impact of additional rate cuts in 2025 on the rate of inflation. The vote was not unanimous; this recent reduction was approved by 11 of the 12 FOMC voters.
Related: *In Preparation for Potential Interest Rate Cuts, Companies Should Start Borrowing Now*
Noteworthy is that inflation, currently at around 2.8%, remains significantly above its target rate. It remains persistent.
As this occurs, banks are facing challenges in generating profit from loans. The cost of attracting deposits is increasing, while at the same time, demand for deposits is becoming scarcer. The Fed aims to aid banks in making loans to small businesses, as these enterprises account for the majority of private sector employment in the economy.
Related: *The Potential Impact of a Trump Presidency on Small Businesses*
As the Trump Administration resumes power in 2025, the Fed will continue to monitor the implications of emerging data for the economic outlook. In 2024, there were issues with inaccurate reporting of job creation in the economy. The Bureau of Labor Statistics revised its job creation figures downward by a significant margin several months after their initial release. The reasons for this inaccuracy in reporting remain unclear.
Strategies for Planning Small Businesses in 2025
The strategic planning of small businesses for 2025 hinges on a few factors. Undoubtedly, the incoming Trump Administration is expected to be more favorable towards businesses. There has already been a noticeable improvement in business confidence in the country.
However, inflation remains a concern. Chair Powell emphasized that if inflation begins to climb again, the Federal Reserve may find it difficult to lower interest rates.
Any business owner with expansion plans and seeking financial support, however, could benefit from the current low-interest rate environment. SBA loans are now at their cheapest levels since the pandemic, and companies with adjustable-rate loans will enjoy immediate cash flow benefits from these reduced rates.
It would be advisable for business owners to adopt a wait-and-see approach to their 2025 planning. They should monitor the first half of 2025 to gauge its direction. The early part of the year may prove challenging, but conditions should improve in the second half.
The impact of interest rate reductions will benefit small and medium-sized banks, which have faced significant exposure in commercial real estate due to their fixed-rate portfolios. A decrease in interest rates will boost the market value of their portfolios, providing relief for these banks, which have struggled over the past two years.
As more capital becomes available, we can expect an increase in lending activity next year. We may also witness an increase in bank mergers and acquisitions in 2025, as well as the streamlining of bank branch networks to reduce fixed costs. All of this is favorable to small business lending.
For business owners with expansion plans, the current interest rate environment may present an ideal opportunity to increase capacity or acquire another company. It will be important to maintain control over fixed costs (rent, mortgages, equipment, vehicles, etc.), since they are difficult to adjust. Variable costs, such as staffing levels and the number of work hours, can be more easily adjusted. In the new year, the key is to build a business that operates efficiently.
- In response to the Federal Reserve's decision, small businesses might consider applying for SBA loans, as they are currently at their cheapest levels since the pandemic due to the low-interest rate environment.
- Jerome Powell, the Chair of the Federal Reserve, noted that if inflation begins to climb again, the Federal Reserve may find it challenging to lower interest rates further, emphasizing the importance of inflation control for businesses.
- To mitigate the challenges faced by banks in generating profit from loans, the Federal Reserve aims to aid banks in making loans to small businesses, which account for the majority of private sector employment in the economy.
- Donald Trump's administration, set to resume power in 2025, will continue to be monitored by the Fed for potential implications on the economic outlook, following issues with inaccurate reporting of job creation in 2024.
