Winners and losers in a new era for interest rates

When inflation soars, central banks hike interest rates to cool demand and - eventually - inflation falls. In economic circles, it’s a story almost as old as time itself. The details may differ, but the same cycle has repeated many times before.

Except this time, it may not be the whole story, even if many of the normal elements are in place. Inflation hit long-forgotten heights in many economies as post-pandemic spending surged, and energy prices erupted on the back of the war in Ukraine. Central banks responded by aggressively pushing up interest rates. The result, as we see today, is that global inflation is declining.

So far, so familiar. But this time, economists are less sure that the cycle is complete. Nobody knows if price volatility is over, and when - or even if - interest rates will be pulled back to pre-crisis levels. In economic as well as political terms, we have entered a new age of unpredictability. In these slippery circumstances, investors, merchants and supply chain participants need to understand who the winners and losers might be.

Headline inflation is falling - but it isn’t the whole story

The good news is that headline inflation is declining. The bad news is that in terms of inflation volatility, the 2020s is beginning to look a lot like the 1980s, a notoriously volatile decade.

There are several reasons for this. Prices are vulnerable to energy and supply chain shocks, and the 2020s have already brought a once-in-a-century global pandemic and the first major European war since 1945. The crisis in the Middle East continues to threaten regional stability, and attacks by Houthi rebels on shipping in the Red Sea have added significant costs to global trade.

Is this just bad luck? Maybe, but the rise of populism, protectionism and political polarisation in the last few years threatens a new era of geo-political tension. The potential for unpredictable inflationary events remains high.

Inflation is more sensitive   

In addition, while goods inflation is staying true to form, prices for services remain stubbornly high. Services inflation was 3.9% in the eurozone in February and 5% in the US. Services inflation tends to be higher than goods inflation, and the pull back of prices is likely to be more limited.   

“Services prices are beginning to stabilise as consumers’ appetite for travel, tourism and other services are waning after the post-pandemic boom,” says Atradius economist, Dana Bodnar. “But other trends may be longer lasting. For example, there’s some evidence that the pass-through from producer prices to headline inflation has increased since the pandemic. As these effects come with a lag, inflation may remain more vulnerable to energy shocks and supply chain disruptions for a longer period of time.”

Labour markets are also volatile. The US economy added 275,000 jobs in February, and worries over AI are adding to labour market instability. A wage-price spiral is unlikely, but uncertainty in the jobs market adds to a sense of economic flux.

The case for caution

As far as central banks are concerned, this all adds to the case for caution. The situation is complicated and evolving, which is likely to persuade policymakers to keep interest rates higher for longer. Even if the first cuts in some economies are still pencilled in for the middle of 2024, the path to lower rates is likely to be slow and stuttering.

So what does this background of inflation volatility and higher-for-longer rates mean for business?

Any business with significant debts will be feeling the pressure from higher rates, which leads to increased debt servicing costs and growing financial instability. It also makes credit more difficult to access, plunging some struggling businesses into serious financial peril.

Some sectors are particularly susceptible to a high interest rate environment. Construction is a classic example, squeezed at both sides of the supply and demand equation. Higher interest rates make mortgages more expensive for consumers and credit more expensive for companies.

Chemicals is another capital-intensive industry, where the increased cost of borrowing can limit output and reduce competitiveness.

Some sectors are resilient to high interest rates

While high interest rates generally dampen economic activity and make business growth more difficult, some sectors ride out the storm more easily than others.

“In general, during times of high inflation and interest rates, government expenditure can provide temporary relief to businesses, helping some fare better than others,” says Dimitri Pelckmans, Head of Risk Services for Atradius in Belgium and Luxembourg. “More specifically, there are positive signs from global manufacturing, which seems to be picking up after a long slowdown. Despite geopolitical tensions in the Red Sea region, which are causing supply delays and rising shipping costs, global manufacturers are currently showing increased confidence. There are already promising signs indicating a potential easing of the trend in global destocking, hinting at a brighter outlook for future demand.”

Finance is another obvious example, as lenders benefit from higher interest on company and consumer credit. But even here, the upside can be short lived. If economic activity is shackled for too long, any advantage can be cancelled out by rising payment defaults and reduced lending activity.

Still, some sectors have displayed considerable resilience in recent months. ICT spending has remained healthy despite sluggish economic activity as businesses seek cost and efficiency savings through the application of better technology. The sector benefits from significant investment in innovations like AI, machine learning and big data, as well as the data centres these advanced technologies require.

“While the ICT sector may not be entirely shielded from a general economic slowdown in the coming months, we expect it to keep growing,” says Atradius industry specialist Kyle Kong. “These businesses are equipped to navigate the challenges posed by elevated interest rates, demonstrating resilience and the capability of seizing growth opportunities.”

For resilience, the energy sector also stands out. On one hand, high rates make it more expensive for energy companies to borrow money for operations of expansion. On the other, demand remains strong. Consumers and businesses cut almost everything before essentials like heat, light and fuel for vehicles and machinery.

“But there's a catch,” says Atradius industry specialist Olaf Gierlichs-Steffens. “Other factors like global tensions, availability of energy, and new technologies can also affect the prices and profits of energy companies, not just interest rates. So, in a nutshell, the effect of high interest rates on profitability depends also on various other internal and external factors.”

Slowdowns likely across the board

The wider point is that, while high-interest rates generally make things harder for many businesses, that’s not the case across the board, at least in the short term. Some sectors and industries are more resilient to volatile inflation and higher interest rates than others. Some companies continue to make healthy profits. 

How long that can continue is open to debate. Eventually, the impact of high interest rates tends to filter through to every area of economic activity. Even fast growing sectors like ICT and transport equipment are likely to experience significant slowdowns over the next few months. In fact, most sectors are likely to see minimal growth through 2024 and even 2025.

"There are very few winners, if any, in the scenario that this high interest rate environment endures indefinitely," concludes Atradius economist, Dana Bodnar. "But the current  unpredictability around inflation means central banks will only approach interest rate cuts with an abundance of caution. Higher interest rates will be here for the foreseeable future.”