The Bank of England has warned that rising interest rates pose a greater risk of default for British companies, which could threaten investment and employment.
According to an analysis posted on the BoE blog, the share of UK non-financial companies that are experiencing debt servicing stress – those with a high ratio of earnings to interest costs – will increase to 50% by the end the year from 45 percent in 2022.
This proportion increased to 70% for medium-sized businesses, those with a turnover between £10mn (£10mn) and £500mn (£500mn). In this scenario, the corporate debt burden would reach its highest level since 2008-09.
The analysis stated that higher interest rates put pressure on corporates who are indebted by increasing debt servicing costs. Such pressure can increase the risk of corporate defaults and lead to a sharp reduction in investment and employment.
UK Interest Rate is currently 5.25 percent, up from a low of 0.1 percent in November 2021. The BoE’s analysis was based on market expectations of a rate increase to 6.1 percent.
David Bharier is the head of research for the British Chambers of Commerce. He said that the BoE analysis matched what he had heard from small and medium-sized businesses (SMEs).
Bharier said that the rising borrowing costs put significant pressure on smaller businesses who, after three years of economic turmoil, were unable to absorb these increases. “Many . . . The real pain will come soon.”
Martin McTague said that the analysis was primarily focused on larger firms, and therefore “doesn’t show the full picture”. He added that small businesses are more vulnerable to interest rate increases than their medium and large counterparts.
According to FSB statistics from the second quarter 2023, one in five small business owners cited financing as the main reason for increased costs. This was the highest percentage to date.
The BoE warned that lenders who are less resilient may be more vulnerable to defaults, as they have low interest coverage.
It warned that a sharp reduction in corporate investment and employment, which occurs when defaults increase, could make future economic downturns even more severe.
Capital Economics analyst Ruth Gregory said that corporate insolvencies are expected to increase “sharply”. This is due to the rising borrowing costs and a stagnant economy.
Separate information provided by the Insolvency Service (a government agency dealing with bankruptcy and liquidations) showed that there were 6,342 company insolvencies registered in England and Wales during the three-month period ending June. This was the highest number since the second quarter 2009. The BoE has also predicted that the number of distressed companies will remain below the peak reached during the 2000 dotcom crash and the financial crisis.
Gregory explains that this was due to the fact that many SMEs, who are more reliant on bank loans than larger companies, had taken out fixed-rate loan at a rate between 2.5 and 10 percent over a period of 6 to 10 years, during the Covid Pandemic.
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