The post-COVID commercial environment continues to be a challenging place for businesses in the UK. The last two years have presented a series of well documented challenges that have raised the cost of trading (or even surviving) as a business to uncomfortable levels: Russia’s invasion of Ukraine, Liz Truss’ government (yes, that really happened), slow economic growth, global supply chain pressures and further geopolitical turbulence.

The combination of these global events have dramatically increased rates of inflation and resulted in central banks increasing interest rates across the globe in an attempt to bring inflation back under control.

Increases in central bank base rates of interest has an obvious and direct impact on the rates of interest that lenders charge on loans they provide to their borrowers. This has an obvious impact on variable or floating rates of interest, but it also impacts the amounts of fees and the margin that lenders charge borrowers. It also reduces lenders’ general appetite for seeking new business and providing debt as the credit facilities they can offer rapidly becomes uncompetitive. This decline in the availability of accessible and affordable debt has been a key factor restricting economic activity over the last 24 months, with fourteen base rate rises implemented by the Bank of England (“BoE”) between December 2021 and August 2023 resulting in ever-increasing interest rates and margins being charged by lenders for the provision of debt. Whilst the UK economy may not be solely reliant on debt, it is certainly heavily fuelled by it and a reduction in the availability of debt, or a reduction in the attractiveness (i.e. affordability) of that debt, has been a major cause of lower deal activity levels and economic growth.

Although Q1 2024 has seen a slow start, Q3 and Q4 of 2023 were fairly busy (this was certainly the case for the majority of the companies, lenders and other law firms we have engaged with over the last year) and there are signs that increased general economic activity and growth may not be too far away. Inflation has been gradually falling since hitting 11.1% in October 2022 and is now holding at 4%. The rate of inflation may still be twice the BoE’s target rate of 2%, general economic growth in the UK has increased recently by 0.1%, which although that is almost the bare minimum amount required for the definition of “growth”, it is better than was predicted. With the last four meetings of the Monetary Policy Committee (the “MPC”) of the BoE resulting in steady interest rates (BoE base rate has been held at 5.25% since August 2023) there is optimism that deal volumes will generally pick up throughout 2024 and into 2025.

Despite inflation having fallen and interest rates becoming more stable, the higher cost of borrowing currently remains a key consideration for businesses in the UK. Mainstream lenders, such as banks, have reacted to the offsetting of the interest that they receive from loans borrowed by their customers by the amount of interest they are required to pay out on deposits by increasing the margins and fees they charge on the debt they provide. Increased costs of mainstream bank debt have created opportunities for challenger banks, alternative lenders, bridging lenders and private equity, but the knock on effect of higher bank rates and fees is that these debt providers also inevitably increase their costs. These alternative debt sources are attractive to active businesses as the debt they can provide is more accessible, quicker to arrange and obtain and the players involved are usually business friendly and easy to work with. However, their terms of borrowing can be less flexible, often non-negotiable, or overly burdensome in terms of security collateral, which can cause some potential borrowers to remain with their existing debt providers, or refinance with other banks and accept higher costs. Even for borrowers who have not actively been looking to grow, refinance or purchase further assets, short-term facility extensions and/or increases required by maturing loan facilities, or amendments triggered by financial covenant breaches have typically resulted in higher margins being charged by their lenders, which ultimately has an impact on their balance sheets.

It is widely expected (or hoped?) that the MPC will reduce interest rates in 2024. Whilst it is unrealistic to expect that such a reduction will eventually lead to a return to an ultra-low interest rate environment (those days are probably gone), the hope is that the ‘new normal’ will likely be a base rate of 2%. A base rate of 0.1% is obviously more attractive to borrowers than a base rate of 2%, but hopefully a base rate at a more sensible level will ultimately support and contribute to a fairer and more predictable economic market, with stability and longevity at its core. If predictions of base rate reductions are correct, and the inevitable lowering of borrowing costs does materialise, hopefully the well-touted maxim of “survive until 25” circulating last year will come to fruition and 2025 will see a return to a more pro-active and motivated marketplace.