What interest rate cuts mean for small businesses

The Federal Open Market Committee (FOMC) of the Federal Reserve voted to cut interest rates again on Wednesday, December 18, raising the target range for the federal funds rate by 1/4 percentage point (25 basis points) to 4 1/4 to 4 lowered 1/2 percent area.

The Committee reported that recent indicators suggest that economic activity continued to grow at a solid pace. Since the beginning of this year, labor market conditions have generally eased and the unemployment rate has increased, but still remains low. Importantly, the economy has made progress toward the Fed’s long-term inflation rate of 2%, but inflation still remains somewhat elevated.

Given the uncertain economic outlook, the FOMC is alert to the risks to both sides of its dual mandate of full employment and the 2% target.

The main reason the Fed has cut interest rates is because overall inflation numbers are looking better. Obviously there was a lot of expectation in the markets that the FOMC would make this rate cut and they did just that. The employment report earlier this month was quite weak, which also justifies this third rate cut in a row.

Related: Why the Fed’s lower interest rates will boost small business earnings

In considering the size and timing of additional adjustments to the target range for the federal funds rate, the Fed indicated that it would carefully consider the incoming data, the evolving outlook and the balance of risks. Since September, the federal funds rate has fallen a full point from its peak. This is a relatively large decline in a short period of time. The FOMC needs to seriously consider whether future rate cuts in 2025 could contribute to an increase in the inflation rate. The vote was not passed unanimously; This latest reduction was approved by 11 out of 12 FOMC voters.

Related: With interest rate cuts likely, businesses should prepare to borrow now

It should be borne in mind that inflation, at just under 3%, is still almost 50% above the target rate. It stays sticky.

While this is happening, banks are finding it difficult to make money on loans. They pay more for their deposits, which are becoming increasingly difficult to attract. Meanwhile, the Fed wants to help banks lend to small businesses, which create the lion’s share of private-sector jobs in the economy.

Related: How small businesses might thrive in a Trump presidency

As we enter 2025 and the return of the Trump administration, the Fed will continue to monitor the impact of incoming information on the economic outlook. One problem in 2024 was inaccurate reporting of job creation in the economy. Months after their release, the Bureau of Labor Statistics revised its job creation numbers significantly downward. It’s unclear – or at least unproven – why they overstated the number of new jobs added to the economy at the beginning of the year.

How should small businesses plan for 2025?

Small business owners’ plans for 2025 depend on two or three things. Obviously the Trump administration is coming, and it’s going to be a lot more business-friendly. We have already seen that small business confidence in the country has risen sharply.

However, inflation is still a challenge. Chairman Powell said the Federal Reserve cannot easily cut interest rates if inflation begins to rise again.

However, for any business owner with growth plans and looking to borrow money, now is a better time than any other time in the last two and a half years. With interest rates already down 1 percent, SBA loans are now cheaper than they have been since the pandemic, and businesses that already have variable rate loans outstanding will see immediate cash flow benefits from these lower rates.

Business owners should take a wait-and-see approach when planning for the new year. You should see how the first half of 2025 develops. Looking at the data, 2025 could be quite difficult at first. Things are likely to get better in the second half of the year.

The impact of the rate cuts will benefit small and medium-sized banks that had large exposure to commercial real estate due to their fixed-rate portfolios. As interest rates fall, the market values ​​of the portfolios will improve, which will be a relief for them as they have suffered greatly over the last two years.

As more capital is released, I expect lending to increase next year. Additionally, I expect an increase in bank mergers and acquisitions in 2025. Additionally, we are likely to see banks rationalize their branch networks to reduce their fixed costs. All of this bodes well for small business lending.

For business owners looking to expand, now could be the right time to add capacity or acquire another business as interest rates have been cut in the last three FOMC meetings. It will be important to keep fixed costs (rents, mortgages, equipment, vehicles, etc.) manageable as they are difficult to adjust. Variable costs such as the number of employees and the number of hours worked are easier to change. The most important thing for the new year is to build an efficient business.