The Federal Reserve has already moved, and the European Central Bank faces a similar step in the near term. The moves are smaller, around half a percentage point, but they set a path to cool price growth while shaping the finances of governments, businesses, and households.
How do high rates affect the state?
In a nation with heavy debt, estimated at roughly 1.5 trillion euros, rising interest rates push up the cost of future funding as the government needs to issue new bonds to replace maturing debt. Inflation helped 2022’s budget balance through robust tax collections, but the inflation-fueled measures used to tame it could weigh on the 2023 budget. If deficits come in above expectations, the extra financing costs could become significant, representing about 15.5% of current government outlays when subsidies and other transfers are included, and about 5.4% of total administration expenditures. In other words, nearly every hundred euros spent, saved, or transferred by all levels of government would go toward interest payments if the accounts balance as planned. The situation isn’t catastrophic, but it depends on economic momentum. If the deficit widens, interest outlays could press toward 1.1 billion euros in 2023. The ECB aims to avoid this, though risk premiums could react if markets begin treating euro debt as riskier, as happened in 2012.
How do high rates affect companies?
The Bank of Spain forecasts that higher borrowing costs will raise the financial burden on indebted firms by roughly 5% to 7%. Profits could shrink, prices may rise, and overall access to financing for businesses may tighten. Credit activity has slowed since the pandemic, with banks prioritizing renewals and refinancing rather than expanding loan books for the productive sector. Delinquency may increase, and it will be harder to roll over or extend support through programs like ICO credits. For small and medium sized enterprises seeking finance, access to affordable funding could become even more constrained as banks remain cautious and credit conditions tighten. Bank debt levels resemble those from fifteen years ago, and more firms may face defaults or extended payment terms as supplier liabilities come due. Profits are likely to fall, and higher financial costs will dampen investment. Larger corporations that rely on market financing rather than banks will see higher funding costs as fixed income markets push rates up, with core inflation moving toward consumer price levels and producers trying to pass higher costs to customers.
In response, small and medium enterprises will seek alternative funding, raise equity where possible, and improve working capital by stretching supplier terms. A higher rate environment tends to push up default risk among firms and extend payment cycles, which in turn compresses margins and dampens investment appetite across the economy.
How do high rates affect individuals?
There is a distinction between borrowers with variable rate loans and those with fixed rates. Mortgage holders with variable rates face ongoing higher costs, while roughly seven in ten homeowners have fixed mortgages, offering some relief against rate volatility. Responsible lending standards mean many fixed rate borrowers will see steadier repayments, though overall borrowing costs will still rise for new credit. Consumer credit becomes more expensive, and competition in that market may intensify as lenders price risk accordingly. This means individuals can fund purchases if they remain creditworthy but at higher interest levels and generally at greater total costs.
The broader effects of rate increases on households are indirect. If inflation cools and the economy slows, unemployment could rise. Additionally, the growing debt service of highly indebted governments coupled with persistent spending pressures could keep taxes elevated, reducing disposable income and, alongside higher prices, constraining consumer choices.