Rising interest rates create more challenges for businesses

Rapidly rising interest rates have put added pressure on businesses, according to a recent survey by the Federal Reserve Bank of Minneapolis.

The July survey received 555 responses from businesses across the Ninth District. Many companies reported lower profits as they continued to struggle with hiring difficulties and high input costs, though they noted that price pressures were moderating from their peak.

Businesses also pulled back modestly on hiring, often pointing to high labor costs and a lack of qualified applicants.

Despite these many challenges, labor demand and the near-term outlook remained positive overall, suggesting both continued resiliency and some optimism.

Revenues vary as profits tilt lower

Changes to revenue varied for businesses in the Ninth District. A slightly higher share of firms experienced revenue declines than those that experienced growth over the year (Figure 1). Expectations for future revenue were mixed as well, with a third of respondents expecting declines and a slightly higher share expecting revenue to increase.

Business owners were much more pessimistic about their profits. Nearly half of respondents reported that profits had declined compared with the same period last year, and profits continued to fall for many over the most recent quarter (Figure 2).

Respondents frequently cited that heightened input and labor costs were eating into their profits, and some were concerned that customers were becoming more price sensitive.

“Our customers already appear tapped out and spending is down, but we have to increase prices to pay increasing wages. We are continuing to see price increases from our suppliers,” commented the owner of a food service business in the Twin Cities.

High input costs and labor availability had been consistently identified as some of the biggest challenges for businesses in past surveys, but rising interest rates became a more significant issue this summer (Figure 3).

When asked how rising rates have affected their businesses, 63 percent of respondents said that current interest rates have had a negative impact. Companies in the manufacturing, construction, and finance sectors felt the effects more acutely than others.

The owner of a manufacturing company in South Dakota commented that rates “have impacted projects for our customers thus driving down business.” Another manufacturing company in Minnesota commented that the current interest rate environment “prevents us from getting new equipment right now because the rates are so high.”

Many smaller businesses were also struggling with the high rates. “As a new business we live and die by loans,” commented the owner of a café in western Minnesota. “Our loans are a heavy burden since we had to take them out this year.”

A small Minnesota business owner in the agriculture industry said he worries about the future of his business due to the high rates. “My interest expense has now risen to the point of jeopardizing the viability of my business,” he commented. “I may be forced into liquidation of assets and downsizing my business which would include laying off almost 100% of my labor force.”

Hiring shows signs of slowing

Amid rising rates, many firms were still hiring in some capacity, but there were signs of slowing. The share of businesses reporting demand for additional full-time workers was smaller compared with last year’s summer survey, and about 40 percent said they were simply hiring to replace turnover (Figure 3). While very few businesses cut staffing levels, a little over a third were no longer hiring.

When asked about their future staffing levels, a majority of businesses said they expect staffing to stay flat over the next six months. “We are hiring positions deemed critical to day-to-day business operations,” commented the owner of a South Dakota utility company. “All other discretionary positions are on hold.”

Many businesses that were hiring were still struggling to fill open positions. Over 60 percent of hiring businesses reported that it was moderately to extremely difficult to find and hire necessary labor. Some added that the lack of staff was impacting their business operations. “Employee shortages are affecting our ability to take on more work,” commented a South Dakota auto repair shop owner. “We are taking less appointments this year due to a lack of help.”

When asked what the greatest challenges were with hiring, respondents most frequently reported that the applicants did not have the right skills or experience for the role. A quarter of respondents also reported that the applicants were looking for wages higher than their businesses could offer.

“We need highly skilled employees to bring our sales up, but we cannot afford to compensate at a rate that reflects the needed skill set,” commented the owner of a Twin Cities manufacturing firm. Another Twin Cities business owner in the professional services sector added, “As a small firm, we have had difficulty hiring computer programmers and developers at a reasonable salary, so it has slowed down development of new products and services.”

Wages still rising, but heightened labor costs add strains

Most businesses have raised wages over the last year, with 28 percent reporting raises over 5 percent and another 30 percent reporting raises between 3 to 5 percent. Many expected to continue raising wages between 1 to 5 percent through the end of the year, but the added labor costs have become difficult to sustain for some businesses.

“We have lowered costs everywhere possible in order to give staff a modest increase in pay,” commented the owner of a manufacturing firm in southern Minnesota. “We are not hiring so we can keep the employees we have.”

Many small businesses owners mentioned that it was difficult to compete with the wages offered by larger businesses in the area. A higher share of firms with one to 10 employees kept wages flat over the year compared with larger businesses. “It’s hard for a small retailer to compete with major fast-food chains,” commented a South Dakota business owner. “I can’t start someone at $17 hour. I just don’t have the cash flow. Larger chains do.”

Other business owners noted that a lack of affordable housing in their area was impacting their labor costs. The owner of a bar near Yellowstone National Park increased starting wages to try to attract more workers but noted that many workers have “no place to live and can’t afford existing accommodations.”

Meanwhile, the café owner in western Minnesota has taken the housing market into consideration when setting wages. “We tie our wages to the price of housing in our area,” she commented. “Housing costs are driving up our labor costs.” Even though labor costs are high, she said they “have been downright mobbed with highly qualified applicants” because of the wages they offer.

Businesses only slightly optimistic about the future

Numerous challenges have battered businesses over the last few years, but even the added strains of heightened labor costs and higher interest rates have not completely soured their outlook.

About 42 percent of respondents are optimistic about the future of their business in the next six months, while a little under a third are pessimistic—results that are a shade better than last summer’s survey. Some business owners are confident they will not have to shut down, but they mentioned there will need to be major cuts to stay afloat.

“Despite taking a big financial hit this year, we will survive,” commented the owner of a South Dakota hotel in the Black Hills. “We will have to cut a lot of staff to make it through and hopefully things will start to balance out better.”

The Federal Reserve Bank of Minneapolis survey of general business conditions was conducted from July 10 through July 24, 2023. We received 555 responses from across the Federal Reserve’s Ninth District, which includes Minnesota, Montana, North Dakota, South Dakota, the Upper Peninsula of Michigan, and northwestern Wisconsin.

About 40 percent of responses came from Minnesota businesses, while a fourth came from South Dakota. All states surveyed had at least 25 responses. Survey results were not obtained from a random or representative sample, and readers should exercise appropriate caution interpreting results.