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Inflation and Your Business – What You Need to Know

Inflation has been in the global news headlines for more than a year now, ever since Russia took the decision to invade Ukraine and trigger a series of events that have contributed to rising energy and food price hikes.

There are other factors in play, of course, but inflation remains disproportionately high at 6% in the US. While inflation rates have declined considerably since the third quarter of 2022, for example, they continue to exceed the Federal Reserve’s target of 2% and pose a significant challenge to entities both at home and abroad.

But what are the fundamental aspects of inflation, and how do they affect businesses? Let’s find out!

What is Inflation?

In technical terms, inflation is measured using indexes such as the Consumer Price Index (CPI), which describes how the price of an average basket of goods changes over a predetermined period of time.

More broadly speaking, inflation reflects the wider value of money within a particular country and timeframe. In instances where inflation rates remain high (as they have done in recent times), the purchasing power of an afflicted currency is likely to be diminished, whereas low or manageable levels of inflation help to optimize currency values and ensure that you’re able to buy more with your money.

Interestingly, inflation is a natural phenomenon in any economy, especially one that’s underpinned by free market principles and the basic rules of competition. 

This is why central banks like the Federal Reserve look to keep the prevailing rate of inflation at around 2%, as this recognises the reality of price rises and helps to keep the cost of living low and stable. Stability is key here, as it enables citizens to plan effectively for the future and businesses to manage their operational costs more effectively.

How Does Inflation Impact Businesses?

This leads us neatly onto the topic of how inflation affects businesses, as rising prices can impact companies in a myriad of ways.

Firstly, rising inflation increases the cost of buying raw materials and goods, with supply pressures ensuring that they have to pay more for specific items. This, in turn, directly undermines profitability, while this effect can also be compounded in instances where customers can no longer afford to pay your prices.

Secondly, it’s important to note that customers are also your employees, and many may find themselves struggling with rising household costs on an individual level. As a result, working for their existing salary may become increasingly untenable, and your staff may ask for help to compensate for the real-world financial impact of inflation.

Interestingly, it should also be noted that central banks (including the Federal Reserve) often look to hike the base rate of interest to help combat inflation. This method of quantitative easing is based on the fact that inflation and interest rates enjoy an inverse relationship, and hiking the base rate creates a greater incentive to save rather than spend cash.

In March, the Fed hiked the base interest rate by a further 0.25 percentage points to 5%, marking the ninth consecutive increase and highest such rate since 2007. 

Of course, this automatically increases the cost of borrowing for businesses, at a time when they’re already struggling with higher operational costs and potentially smaller profit margins. While it may deliver results by ultimately lowering inflation (the rate should hit 5% in the US in the coming quarter), companies are having to cope with a perfect economic storm in the meantime.

What’s the Outlook for the Rest of 2023?

Ultimately, inflation is falling quicker in the US than elsewhere else, with the UK still reporting double digit rates in excess of 10%.

At the same time, economists are now predicting that a global recession is increasingly unlikely, with the US currently at the forefront of driving growth and attempting to create some semblance of economic normality on the world’s stage.

This is at least creating a sense of optimism among business owners in the US, as the continued fall in inflation will be followed by swift reductions in the prevailing base interest rate. Over the course of H2 2023, this should translate into reduced operational costs and more accessible borrowing, which may enable companies to balance their books and invest in tentative growth going forward.

However, further potential crises’ remain on the horizon in the housing and banking sectors, which will remind many of the circumstances that precipitated the great financial crash of 2008. 

So, US firms aren’t completely out of the woods yet, and there remains a need for consolidation and pragmatic financial management if the world of business is to avoid significant depreciation through 2023.