High Inflation and High Rates: What Businesses should Keep an Eye on

September 13, 2022

By Atul Oka, Senior Director of Strategy and Business Development, DUKE Heights BIA

As interest rates increase in an effort to battle high inflation, Canadian businesses face greater uncertainty. Interest rates can have an impact on a business’s cash flow, ability to borrow, growth strategy, and hiring plans. With the latest increase of seventy-five basis points (0.75%) by the Bank of Canada in September 2022, Canada now has the highest policy interest rate among all G7 countries. The current overnight rate of 3.25% is the highest since 2008, and with an inflation reading of 7.6% in July, the Bank of Canada is expected to keep raising rates until there is a sustained decrease in inflation.

Conversely, these increases while significant, have only been possible because of confidence in the economy’s recovery as evidenced by strong job growth and an unemployment rate at the all-time low of 4.9% (July 2022 reading). In a strategy similar to the one employed by the US Federal Reserve, the Bank of Canada has “front-loaded” the interest rate increases in an effort to reduce overall spending and thus the demand for goods and services.

Because rate changes have a lagging impact, there is now an increased risk of recession should the Bank of Canada continue to raise interest rates at the current pace. The CMHC is currently predicting a recession at the end of 2022. Whether there is a recession or just a slowdown, businesses in Canada will need to understand how the rate environment will impact their business.

The most important impact for many businesses that have taken on a high level of debt during the preceding period of low rates to boost capital investment and growth is their ability to service debt. In addition to higher input costs as a result of inflation and a possible slowdown in demand, businesses now face an increase in the cost of servicing existing debt and a decreased ability to access increased debt. Companies that have low margins and high debt will be hit especially hard by the potential “cash flow crunch”. Managing and forecasting cash flow will thus be critical for many businesses if they are to effectively mitigate this risk.

Wage inflation and the ability to hire new workers in the short term may also impact businesses during the initial interest rate cycle. Over the last two years, many workers left the labour force leaving businesses struggling to fill open positions. This in turn resulted in wage inflation as businesses attempted to retain and grow their headcount. Businesses may therefore continue to face human resource challenges until the labour market cools down which is only expected in late 2022 or 2023 when demand destruction leads to increased layoffs.

Another challenge that not even large international companies like Walmart and Target have been able to successfully manage is forecasting demand and thus inventory. Some businesses may hedge against inflation by accumulating inventory and locking in prices before they increase, or over-order, if supply chains remain unstable, but carrying a large inventory, can tie up precious funds if the inventory cannot be moved at the rate expected. Businesses should be cautious about excess inventory, especially in light of the manufactured slowdown in consumer and corporate demand as a result of higher interest rates.

It is thus important for businesses to incorporate these challenges and risks when creating, evaluating, or adjusting their business plan or strategy.

The DUKE Heights BIA offers free financial planning assistance for members. You can access this service HERE.