Inflation

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Many Americans are wondering which direction the economy is going as we start to see food prices and gas prices leveling out, but mortgage rates skyrocketing. With the abundance of conflicting interpretations of inflation data, it’s difficult to understand what’s next. In this article, we take a look at inflation today and how it is impacting small business owners and consumers.

Is inflation slowing down?

The monthly increase in inflation rates during 2022 does appear to be slowing down from the June 2022 peak rate of 9.1, but there is no way to say for sure if the rate will decrease, increase, or stabilize as we look forward to next year.

Where is inflation today?

The most recent inflation report by the U.S. Labor Department on November 10, 2022, listed the inflation rate at 7.7%. That is an annual rate calculated for the twelve-month period ending October 31, 2022. Updated data that gives the inflation rate for the twelve months ending November 30th will next be released on December 13th, 2022. At 7.7%, inflation is the highest it has been since 1982. At the year-end of 2020, inflation was at 1.4% with a monthly average of 1.2%. At the close of 2021, the inflation rate had risen to 7% with an average of 4.7% for the year. Inflation fluctuated between 0.1% and 3.4% between 2000 and 2019.

While we look at the rate calculated for the twelve months ending in December to summarize the inflation rate for each year, inflation is calculated using Consumer Price Index (CPI) data. The CPI is provided by the Bureau of Labor Statistics of the United States Department of Labor and is defined as “a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.”

As inflation, or the general price increases of goods and services, rises; the U.S. Central Bank, also known as the Federal Reserve, combats inflation by raising the federal funds rate. When the federal funds rate increases, interest rates are increased in an effort to slow the economy down and allow supply to catch up to consumer demand. The Federal Reserve decides on actions surrounding the Federal Funds rate during the scheduled Federal Open Market Committee (FOMC) meetings.

Since the beginning of 2022, the Fed funds rate has increased six times, which is the highest number of rate increases since 2005. To make matters tougher for consumers, borrowers, and small businesses, the rate increases during 2022, unlike in 2005, have each been significant. The last four Federal Reserve rate hikes, which occurred between June and last month, have each been 75 basis points. The current Federal Funds rate is 3.75% to 4%. The next FOMC meeting is scheduled around December 14th, when the Feds will make a decision on a seventh rate hike of 2022.

Will there be another rate hike in December?

Since the data that will be considered by the Federal Reserve is not yet available, it is impossible to precisely say what will happen at the next FOMC meeting when it comes to the Federal Funds rate. However, many economists, including Forbes.com Senior contributor, Simon Moore, say we will “likely see another hike.” As November CPI and annual inflation rates are made available, the following economic data will contribute to the December decision.

  • Inflation rate – the inflation rate will be calculated using CPI reports, Personal Consumption Expenditures (PCE) and Producer Price Index (PPI) data, in that if U.S. inflation continues to increase the Fed will be more likely to decide on another three-quarter percentage point increase
  • Job market – the November Employment Report will be reviewed to see how the labor market has been affected in recent months and what the unemployment rate is, both factors will be considered when deciding how high of a rate increase to impose
  • Speeches and notes – the Fed agrees on its monetary policy and rate hike decisions with a vote that is influenced by reviewing past meeting notes and hearing influential speakers, like Jerome Powell, the 16th chair of the Federal Reserve, who will speak at the final FOMC meeting of 2022

How inflation affects consumers

Hearing the details of the soaring inflation rates and threats of a potential recession can be intimidating, but it’s important to understand how inflation affects your business and consumer spending. Consumers feel the effects of inflation through many everyday financial transactions, like comparing housing costs and personal loan interest rates.

Borrowing power

As the Federal Funds rate increases, the interest rates for small business loans, personal loans, and consumer mortgages increase. When the Federal Reserve hikes the Federal Funds rate, interest rates for consumer loans are also affected because they are based on standardized rates like the PRIME or LIBOR rates. By raising interest rates, the government is trying to control consumer spending by making it more expensive to borrow money.

However, interest rates are the major factor when determining the overall financing costs of a personal loan, line of credit, or credit card. Fixed interest rates remain the same over the life of a loan but are quoted higher by lenders when the Fed rate is high because the financial institution is passing through its own increased borrowing cost to the consumer. Variable interest rates fluctuate over the life of a loan based on the current PRIME, LIBOR, or other market rate indicator. Typically loans with variable interest rates have a base rate that is then added to the current market rate to calculate interest expense each month.

Annual salary increases

As the cost of living, like rent and grocery prices, increase with inflation, many consumers turn to their employers to inquire about a raise. According to CNBC, “wages were much higher over the last year than in previous years with the average merit increase being 4.8%, which is well above the standardized merit increase rate of 3% year-over-year.”

Most consumers are not experiencing enough of an increase in pay to combat the rising prices of everyday necessities, but many are hopeful that standard salary raises will continue to be above average throughout 2023. The unemployment rate is currently steady at 3.6%, but the pressure on employers to increase wages could also create an increase in unemployment.

Cost of living

Most consumers first notice the effects of the economic slowdown in their everyday personal finances because the following expenses are on the rise:

  • Food costs
  • Travel expenses, like flights and hotels
  • Rent increases
  • Medical care costs
  • Gas prices
  • Utility and energy prices, like household electric and natural gas

The increased costs of living are due mostly to inflation, which has been driven by many events during the past year including, the war in Ukraine, the pandemic, and the supply chain disruptions.

Investment income

Inflation and increasing interest rates impact the cost of borrowing money, but they also affect investments, like those held on the New York stock exchange (NYSE). As inflation peaks, many investors sell their stock shares, so the share value of investments drop, and consumers earn less money in the stock market. At the same time, increased interest rates mean higher interest and dividend income on C.D.s, money market accounts, and bonds.

How inflation affects small businesses

Small business owners feel the effects of inflation in every area of their business including business lending, hiring, supply costs, and revenues. While inflation impacts entrepreneurs in the same ways it affects consumers, there are several other factors that can influence annual revenues, net income, and the success of a small business.

Workforce

As discussed in the previous section, rising prices directly impact the labor market’s demands for higher wages. Employers are forced to weigh the pros and cons of giving wage increases against their concerns of declining income and potential layoffs. In addition to asking for salary increases, many employees have begun requesting hybrid work environments where they are able to work remotely at least part of the time. Small business owners may be able to fight the burden of wage increase demands by offering a more flexible work schedule or remote working abilities.

Revenues

When the cost-of-living increases, consumers begin to worry more about putting food on the table, keeping their jobs, and affording increased borrowing costs. The financial strain on households bleeds into small businesses because consumer spending slows down. People stop spending money on luxury and non-essential items which in turn negatively impacts the sales of many small businesses.

Interest rates

Interest rate hikes can affect entrepreneurs in the same ways it affects consumers. The cost of new business loans increases because of higher interest rates, which also affect eligibility requirements and monthly payment amounts. Business borrowers with variable interest rate loans are suddenly seeing much higher monthly borrowing costs and may not have enough working capital left over to cover other business expenditures. At the same time, the higher borrowing costs may discourage customers from making large purchases or buying products and services with credit cards.

Supply costs

At the height of the Covid-19 crisis, Americans felt the effects of supply chain issues, labor shortages, and plant closures. As President Joe Biden worked hard to create solutions for many of the supply chain disruptions, the costs of raw materials continue to increase with rising inflation rates. When raw materials cost more, small business owners are forced to pay more for office supplies, inventory, and everyday operating essentials.

How to cope with fluctuating inflationary rates

During times of high inflation, there are steps small business owners can take to secure the future of their organization. While there is little certainty in knowing how long we will be fighting rising prices, implementing the following strategies may help your business thrive during fluctuating inflation rates.

Cut costs

Operating expenses naturally increase during inflation, but there are many expenses that can be reduced during high inflation. Try cutting back on the following business expenditures:

  • Leasing costs – Examine your business model to see if there’s room to eliminate the expense of office space. Can your employees work from home? Can you share office space with another business?
  • Reduce inventories – Try to keep less inventory on hand so that both purchasing costs and storage costs and space needs can be cut.
  • Renegotiate contracts – Reach out to vendors about negotiating your prices. You may be able to secure a discount by agreeing to sign a longer contract or changing delivery frequency.
  • Decrease advertising costs– Consider cost-effective efforts to market products and services, like email campaigns or building a social media presence.

Consider additional capital

Even though interest rates are higher than they were last year at this time, there are situations when it makes sense for an entrepreneur to consider business financing options. If you are struggling to make monthly debt payments, you may benefit from refinancing your current loans, like Tim Orson, of the Shear Shack Salon was able to do with Biz2Credit’s help. If you are concerned that you may not have the cash flow to cover operating costs or make a necessary repair or purchase, speak with a lender today about a Merchant Cash Advance or business line of credit.

Final Thoughts

The price increases of everyday essentials, like groceries, fuel, and housing, have started to stabilize, but Americans are still dealing with the highest inflation rates they’ve experienced in forty years. While the Federal Reserve increases interest rates as a way to slow spending and fight inflation, increased interest rates on top of rising prices can leave small business owners wondering how much more they can take. If you’re not sure what the next right move for your company’s financial health is, reach out to Biz2Credit to see if there’s a financing option that’s right for your situation.

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