Lockton Monthly Macro Series: Interest rates risks and response

In short:

  • Interest rates increased by 50 base points from 1.35% to 1.85% in August 2022.

  • In the second edition of Lockton’s Monthly Macro Series, our trade credit insurance and risk experts explore interest rate risks in the short-term and the impacts on businesses.

  • Learn some key risk management actions to take, including supply chain management.

  • See why businesses are using trade credit insurance.

In the second edition of Lockton’s Monthly Macro Series, our trade credit insurance and risk experts explore interest rate risks and the impacts on businesses.

What’s driving interest rates?

Interest rates have been increasing over the past few months in response to inflationary pressures in the hope to bring inflation to the target 2-3% range.

Interest rates have been rising to further ease the impact of supply-chain disruptions and shocks due to heightened consumer demand, increased price levels and tight labour market conditions.

Tightened monetary policy is also attributed to the ongoing uncertainties in the global economic outlook, particularly the Ukraine-Russian conflict, increasing international inflation rates, high commodity prices (potentially easing), and prevalence of COVID-19.

Impacts of interest rates

So what are some of the impacts of higher interest rates?

1. Borrowing rates are set to rise after record-low interest levels, increasing business’ financial costs. There may be increased difficulties in the servicing requirements of debt due to rising interest rates, which will have a particular impact on leveraged debt and asset prices.

2. Consumer demand is likely to weaken as interest rates are set to discourage spending. This will have a negative impact on cash flow as the shortage in the money supply will decrease both consumer and business confidence.

3. Increased difficulties in securing bank loans impacting capital available for business growth and investment. Businesses are increasing relying on the non-bank sector.

What are the key areas of impact on businesses?

1. Inflation pressures

Contractionary monetary policy is utilised to restrict further inflation growth. This will bring price levels back to a suitable rate over the medium run.

2. Consumer and business demand

The decrease in the money supply will weaken consumer and business confidence due to further expenditure restrictions. This cycling demand impacts business’ profit margins as businesses are less likely to spend money due to tightened market conditions.

3. Cash flow

Higher interest rates increase the cost of servicing debt, weakening margins. The decrease in consumption will cause a shortage of funds that is necessary to cover fixed costs. The cash conversion cycle for businesses may increase due to the disruption in the inventory-to-sales pipeline, tightening cash flow.

What can businesses do to manage interest rate risks?

Here are three key risk management actions to take:

1. Better cash flow management

Seek to understand the nature of clients the business transacts with, and how increases in interest can impact their ability to pay on time.

2. Supply chain management

It is crucial for businesses to maintain appropriate stock levels to reduce inventory and unnecessary overhead costs. An efficient supply chain will support a stronger cash flow and improve risk mitigation.

3. Prepare for financial scrutiny

It is important to be prepared for greater financial scrutiny from financiers, credit insurers, suppliers, and other stakeholders.

What is trade credit insurance?

Increasingly, businesses are using trade credit insurance to respond for:

1. Accounts receivable protection

Access to real-time insights that allow them to understand the credit strength of current and potential customers.

2. Enhanced credit risk management strategy

Access to trade credit insurers’ comprehensive databases, monitoring systems, collections services, credit checks.

3. Protect cash flow and profit

Get claims paid quickly, enabling them to confidently continue to trade and pay their employees and suppliers.

This is the second edition of Lockton’s Lockton Monthly Macro Series with a spotlight on interest rate risks and how businesses can respond. If you have any feedback, you can contact our experts:

Liam Berry - M: +61 481 438 374 E: Liam.Berry@lockton.com

Sam Rodda - M: +61 478 976 648 E: Sam.Rodda@lockton.com