The impact of inflation on small businesses has been severe and is likely to continue into 2023

US economic growth has slowed significantly in 2022 and that sluggish growth is expected to continue next year. After a slight contraction in the first half of this year, real gross domestic product recovered in the third quarter to an annual growth rate of 2.6%. However, according to Christopher J. Waller, a member of the Federal Reserve Board of Governors, this was only a temporary stimulus and weak growth has returned in the last quarter of 2022 and will continue into 2023.

Consumer and business spending has declined amid deteriorating business confidence across most sectors of the economy, Waller said at the 59th Annual Economic Forecast Luncheon, Phoenix on Nov 16 It’s not hard to see why: inflation remains high, which people notice every day at gas stations and supermarkets. Further, as the Fed tries to bring inflation back to its target of 2%, it has raised interest rates, increasing borrowing costs for both businesses and consumers.

Inflation is a result of, among other things, pent-up demand due to post-COVID-related lockdowns, supply chain issues, higher labor costs and rising gas prices. Stimulus money put more money in the hands of consumers, who of course spent it, fueling inflation. The slowdown in economic growth is a sign that the monetary policy of rate hikes, in place since late 2021, is starting to work, but will take time.

The most recent Consumer Price Index (CPI) report found a slowdown in the pace of price increases, but Waller says it’s much too early to conclude that inflation is on a sustained downward trajectory. It is possible that the Fed will aggressively try to reduce them by raising rates again. After all, over the past nine months, the FOMC has raised the target range for the federal funds rate from near zero to 3-3/4 to 4%, a historic high rate of increases.

All this puts small business owners in a difficult position. On the one hand, they suffer from the tight labor market, which has pushed up wages, and the rising cost of goods sold. Many small business owners were afraid to raise prices further as it could have a negative effect on demand, but at the same time their margins have come under pressure.

This economic reality increases the challenges for small businesses seeking working capital in current and future growth plans. This is evident from the latest Biz2Credit Small Business Lending Index business loan approval rates at major banks fell to 14.7%, a second month in a row. Even as the economy has steadily recovered from pandemic lockdowns, approval rates are still about half what they were before COVID hit the United States.

In addition, in February 2020, small banks approved more than half of the business financing applications received. Now that figure is 21.2%. Interest rates are higher and it’s harder to get loans, in part because cost structures have eroded the profitability of smaller companies.

Half of small businesses (50%) say inflation is the biggest challenge facing small businesses right now, according to the American Chamber of Commerce. The chamber also reported that to cope with inflation, 7 in 10 small businesses increased their prices in response to inflationary pressures, followed by those who said they had taken out a loan (40%), reduced their workforce ( 37%) or the quality of their products or services (31%).

More than three-quarters of small business owners (76%) say they have a plan to adapt to a changing economy, and a large majority (61%) believe the economy is now changing faster than before. A significant percentage (40%) say they are very concerned about the impact of rising interest rates on their business.

There is no doubt that times are tough for small business owners right now. It is important to note the resilience of American entrepreneurs. They endured an unprecedented pandemic followed by record inflation. The strong indeed survive. The holiday season is upon us and consumers are still willing to spend their money. Even if sales are strong, higher costs will hurt profitability. It’s too early to say the holidays are merry and bright, but if labor, fuel and raw material costs don’t start to fall, small businesses could be in trouble for the year ahead.