How do Bank of England interest rate rises affect small businesses? 

Chloe Bell
By Chloë Bell, Content Journalist

The Bank of England has frozen interest rates at 5.25%. This is the first time since November 2021 that rates haven't risen. But why have we seen 14 consecutive months of interest rate rises and how do they affect small business owners? 

Before we go into that, let’s outline some key terms you’ll need to be familiar with for any of this to make sense: 

  • Inflation - Measured as a percentage, inflation is the rate at which the cost of goods and services increases over time. 
  • Core inflation – Measured as a percentage, inflation is the rate at which the cost of goods and services increases over time, but excludes the cost of energy, food, alcohol and tobacco. 
  • Consumer Price Index (CPI) - This is the main measure of inflation. It calculates the average price increase (as a percentage) of a basket of household goods and services. 
  • Consumer Prices Index including owner occupiers' housing costs (CPIH) - This is another measure of inflation that includes everything in the CPI and adds owner occupiers' housing costs and Council Tax. 
A sign outside the Bank of England building in London. The B of E has increased interest rates for 14 months straight and it's making life harder for small business owners.

What are the latest UK interest rates? 

The Bank of England is the UK’s central bank. It works independently from the government but alongside the treasury to keep inflation at bay. Here are the key points to take away: 

  • Interest rates increased to 5.25% on August 3, 2023
  • This was a hike of roughly 0.25 percentage points 
  • Rates are at their highest since April 2008 
  • Rates have increased rates 14 times since December 2021 
  • September 2023 saw rate rises put on hold.

Why has the Bank of England increased interest rates? 

During the pandemic, interest rates were at an all-time low of 0.01%.  

Multiple lockdowns meant people were spending less and the demand for consumer credit dropped. This cast uncertainty over the future of many businesses, and the demand for credit remained relatively low for some time afterwards, possibly due to a build-up in household savings during the lockdowns.  

Although interest rate rises have been put on hold, they've been steadily rising since December 2021, and inflation has been cited as one of the main reasons for the increases.  

Inflation has been rising sharply since March 2021 for several reasons. It started when the increased demand for goods and services as we came out of lockdown was met with supply chain issues - when demand outstrips supply, prices inevitably go up. The war in Ukraine then hit both energy and food prices and inflation rose even more rapidly. 

Putting up interest rates is the Bank of England’s main mechanism for dealing with inflation – higher interest rates mean less money will be spent on goods and services, then as supply begins to outstrip demand, prices stop increasing so much and inflation slows down.  

The Bank of England estimates that this usually takes around two years to work.  

Additionally, putting up interest rates can increase the value of the pound as higher interest rates tend to attract foreign investment. This then means products from overseas can be imported more cheaply, which can also help to lower inflation. 

Who is affected by interest rate rises? 

Pretty much everyone has been affected by these interest rate rises. Borrowers have been hit by higher lending rates, especially on mortgages, while savers have been frustrated as banks have been slow to pass the higher interest rates on to their savings accounts. 

And soaring inflation has increased the cost of living for everyone - the price of everything has gone up, from buying essentials to going out socially, and generally just covering living costs. 

But you will likely feel the pinch more if you have a mortgage, savings account or any sort of loan. Repayments will go up, plus if you were thinking of getting a loan you may find you cannot afford it anymore. Even if you rent, it could have a knock-on effect as your landlord increases your payments to cover higher mortgage costs. 

Small businesses are being hit hard - facing increased overheads, higher commercial mortgage or rent repayments, the cost of borrowing on business loans and credit cards has increased, and it’s more expensive to buy stock and ingredients.  

If you run a restaurant or café, you might have to reconsider more expensive items on your menu and trade them for something cheaper.  

Peter Kinsella, who runs the Liverpool-based, Catalan-inspired restaurant and deli, Lunya, has said: “It’s difficult to make a profit. Of every pound a customer spends, 20p goes to the government for VAT. 

“We’re left with 80p. Then 20p goes towards food and drink costs, 60p for rent, utilities, overheads and staff costs. And in normal times you get 10p profit. But this year it’s just about getting through. We’ve had to take things like octopus off the menu because it’s just become too expensive.” 

Is there anything business owners can do to tackle the double-whammy of rising inflation and interest rates? 

What can small business owners do to cope with high interest rates and inflation? 

If you’re a small business owner, you’ll most likely be hit by the effects of high interest rates in the following circumstances: 

  • You have a short-term loan or a commercial mortgage - High rates mean higher borrowing costs and as small businesses often take out loans to grow and invest, you may find that this is no longer possible. 
  • You are paying rent - You may find your landlord has to put rent prices up to cover increased mortgage costs or even to make a profit themselves. 

You may also be losing money because customers with less disposable income won’t be able to spend as much money at your business.  

What can you do to help your business?  

Things are tough for business owners right now (has it been anything but for the last few years?) and it can be hard to know what to do for the best.  

You may be losing customers because they can’t afford to spend but you still need to make a profit so you can buy stock and ingredients, cover rent, and pay your staff – all the basics you need to keep going.   

Here are some things you can try to keep costs down or maybe even increase revenue

Put your own costs up and assess your stock 

One thing you could try is putting your own costs up to increase your profits. It’s certainly not ideal, but at the end of the day, you still need to be making money from your business. Try increasing costs very slowly. If you run a coffee shop, start off by adding a tiny amount (say 20p or 30p) to the price of a coffee or sandwich each month. Also, take a look at specialist items you sell and work out if it’s worth your while to keep stocking them. For example, is there a certain sandwich filling that doesn’t get too much interest? Do you order handmade cakes that get thrown out at the end of most days? See what is working and what isn’t.  

Try upselling or cross-selling 

Another thing you could try is upselling. This means selling a more expensive, high-end product or service to a customer. You are “selling up” - giving the customer something more than they originally planned, but this should be done in their best interests.   

For example, if you run a car wash - you might have bronze, silver, gold and platinum packages. If a customer books a bronze package - you could ask if they would like the car waxed and hand-dried for an extra shiny finish. If they agree, you can suggest upgrading them to a silver package or gold package for a small price increase, but a better service.   

You could also try cross-selling. This is essentially selling another product to complement what the customer is already buying.  Here are some examples of cross-selling in different sectors. For example, in a Fish and Chip shop, if a customer orders cod and chips, cross-selling would be as simple as offering mushy peas, a sausage, or curry sauce on the side.  The key is to suggest your most profitable items, without being forceful - but still clearly stating the benefits. 

See what jobs you can take on yourself 

It would be great to have a whole team to make running your business 100 times easier, but sometimes it’s just not possible, especially in the bad economic situations we’re facing now. So, look at jobs within your business you could do yourself. For example, do you outsource your bookkeeping or cleaning? Could you maybe save some pounds by doing these things yourself (provided you’re qualified)? Every penny saved helps and you can invest the saved money back into your business.  

Limit spending 

Higher interest rates may have a negative effect on your business cash flow and decrease how much you’re spending each month. You may have had plans to renovate, expand or spruce up your premises, but try not to spend on things that are unnecessary in the current climate. You don’t have to forget about revamping your business, just put the idea on hold for a while while you balance the books and save some money.  

Try to reduce your overheads too. If you own the premises, maybe you could look into leasing out your office space when you’re not using it or assessing your staff costs. 

Check existing debt 

It might be tempting to take out another business loan if you’re struggling with the cost of living crisis and rising inflation, but the interest rate rises mean you’ll likely be paying more back each month until the hikes go back down. 

You don’t want to end up only paying off the interest on your credit cards, rather than the balance, so make sure you assess your financial situation before you decide to take out another type of loan. 

But also, try to speak to other parts of your supply chain to see if there is any wiggle room with your agreement. You could try to negotiate new payment terms with suppliers or try bulk buying items or ingredients you use a lot, for example, bread, butter and milk if you run a café.  

Trade at lower margins  

During times when inflation is high, customers may be attracted to good deals. Lowering your margin means you may make less profit, but if it's reflected in your prices then you could sell more volume. Especially with effective marketing around any price changes.  

But what does this mean in practice? 

If you're a restaurant and you lower your margins and prices on main dishes - you take less profit from the items you sell, but you could entice customers in with low-cost products. If you price items lower, customers might buy more of them because it's such a good deal. This means you could make more revenue than you would otherwise. For more specific ideas on how to boost income, check out our blog on increasing revenue as an SME owner

Is inflation coming down? 

Inflation is coming down. After peaking at about 9.6% in October 2022, CPIH had dropped to around 6.4% by July 2023. Core inflation peaked at 7.1% in May but dropped to 6.9% in June and July. 

The Bank of England has said inflation is “expected to fall sharply from April” and it has predicted it to drop to 5.0% by the end of 2023. It expects to hit its target of 2% inflation by 2025. 

On the one hand, it could be argued that the Bank of England’s tactic of increasing interest rates is working – inflation is coming down after all.  

But it could also be argued that increasing interest rates isn’t the right thing to do in the current circumstances. Soaring food and energy costs mean that people are spending more and more money on the essentials they need to keep their homes and businesses running – putting up interest rates and, in turn, making rent and mortgage payments more expensive, won’t help with this. It will only squeeze people even more. 

If Bank of England forecasts are correct, it will take four years of increased interest rates to bring inflation down to its target level of 2%. Price rises should continue to slow down during this time, but it could mean more tough months are ahead.