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As Interest Rates Rise, Small Businesses Look Out

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July 1, 2004 -- All that cheap capital that has helped the economy recover in the last few years just got a little bit more expensive.

The Federal Reserve raised short-term interest rates for the first time in four years on Wednesday, increasing the target from its 46-year low by a quarter point to 1.25 percent.

Though the effect of the increase on small businesses will be minimal in the short run, small firms should expect interest rates to rise steadily in the next year, which could prove to be a real problem for those with variable-rate loans, experts said. Small businesses are more likely to rely on bank loans that carry these variable rates than their larger counterparts, noted one analyst.

"A lot of small businesses have floating rate loans that are tied to the prime rate, which moves almost in lockstep with the Fed funds rate," said Lee Price, research director at the Economic Policy Institute, a Washington, D.C. research group. Price has projected the short-term rate to rise to somewhere between 2 percent and 3 percent in the next 12 months.

If businesses locked in interest rates while they were at their historical lows of the past few years, they aren't likely to be affected, noted William Dunkelberg, chief economist for the National Federation of Independent Business. He pointed out that cash has been a readily available commodity for businesses for some time now and credit needs should be minimal.

However, Dunkelberg, who in the near term expects the Fed to increase rates by a quarter point in each of its next three meetings, raised concerns about the home construction market, which has long been a boon to the economy.

"One of these days, homebuilders are going to be hit," he said. "And it's not so much going to be the builder as it's going to be the buyer. Rising interests rate will have an effect on demand."

Businesses that carry large amounts of inventory might also encounter difficulties, said Dunkelberg.

New Heights Manufacturing, Inc. of Marietta, GA is a small defense contractor, which relies heavily on the credit markets because of its substantial inventory.

"Our growth is financed by debt, so any increase in interest rates hurts us," said Adam Strange, president and chief executive officer of New Heights. As rates continue to rise, "We'll carry less inventory. That's what we'll have to do."





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