Economic Update: navigating structurally higher interest rates

The era of low interest rates and boundless globalisation is definitely behind us. Today, Belgian entrepreneurs are navigating an economic reality dictated by structurally higher interest rates, significant budgetary challenges and geopolitical fault lines. In this Economic Update, Koen De Leus, Chief Economist at BNP Paribas Fortis, analyses the macroeconomic shifts. Above all, he explains how you can put these tips and advice into practice: how do you steer your business safely and profitably through these volatile years of transition?

The relentless rise of the term premium

Anyone secretly hoping for a quick return to the historic lows of the past decade would be well advised to let that pipe dream go. Interest rates naturally fluctuate in line with the economic cycle, but the fundamental baseline has been permanently raised.

The driving force behind this structural increase is the term premium. This is the risk premium that investors demand to tie up their capital in bonds for longer periods. "Between 2010 and 2020, that premium was kept artificially low by central banks’ asset purchase programmes," explains De Leus. “Today, that premium has risen from -1% to around +1%, and there is a real chance that we will return to the historical average of 2% or more in the long run.”

There are countless reasons for this. We are currently in a period of geopolitical volatility, sometimes referred to by historians as the Fourth Turning, in which (trade) conflicts and protectionism are on the rise. Combine that uncertainty with the massive investment demands of climate transition, rising defence budgets and the costs of an ageing population, and you get an economy structurally more prone to inflationary shocks. Moreover, capital has become more expensive and will remain so for some time.

Why cutting public spending is good for the economy

As well as interest rates, the national debt also hangs over the market like a dark cloud. Billions in savings are needed at both European and Belgian level. But do these severe budgetary cuts threaten to bring the economy to a standstill?

According to De Leus, history offers a hopeful yet sobering perspective. A comprehensive analysis of consolidation periods in 18 European countries shows that how a government implements fiscal consolidation is crucial. "Countries that reduced their budget deficits by raising taxes saw their economic growth average 1 percentage point lower over the following 4 years compared to the period before consolidation. But governments that had the courage to structurally cut spending experienced a significant boost in the long run: their economies grew by about 1 percentage point more in the years that followed."

“The advice to policymakers is clear: keep spending under control - or cut it.” Koen De Leus

What’s more, our economy is currently being thrown an unexpected lifeline from Germany. After years of underinvestment, Europe’s largest economy is now pumping massive capital into defence, infrastructure, energy and digitalisation. This wave of investment is creating a positive tailwind that Belgian suppliers and SMEs can also benefit from, which goes some way towards protecting our country from stagnation.

Investment is shifting from expansion to efficiency

This higher interest rate is clearly being felt in the business world. Although its impact has been rapid, it’s more unevenly distributed. Variable loans are set to become more expensive straight away. Fixed-coupon bonds provide companies with temporary protection until they need to refinance, but this form of financing via corporate bonds is far less common in Belgium and Europe. The companies with high leverage, low credit quality or weak cash flows are hit first. As a result, sectors such as commercial real estate, construction and cyclical, smaller companies are now much more vulnerable than cash-rich multinationals.

Surveys show that companies are gradually beginning to feel the impact of higher borrowing rates. However, we are nowhere near the situation we faced in 2022–2023, when the ECB’s interest rates rose rapidly and remained high for a prolonged period. Still, the financial situation of companies remains relatively sound. Since the peak in 2009, Belgian companies have reduced the number of outstanding loans, meaning that most companies have not faced any real financial difficulties. Nevertheless, there is a pressing need for better monitoring of loans: the percentage of non-performing loans (NPLs) has risen from a low of 2.75% in 2023 to 3.6% today. Historically speaking, however, this remains at a relatively low level.

Whereas a few years ago, loans were dirt-cheap to finance reckless expansion, that tap has now been largely turned off.

"Across the eurozone, we are seeing a sharp decline in pure expansionary investment, such as the construction of additional factories." Koen De Leus

What we do see, however, is a deliberate focus on rationalisation. These days, companies are investing their resources in a very targeted way to reduce operating costs. This is translated into energy efficiency projects, greening vehicle fleets and business processes, and the integration of artificial intelligence. Particularly in energy-intensive sectors, this drive for efficiency is not a luxury, but an absolute prerequisite for remaining internationally competitive, given that European energy prices are structurally higher than in the United States or Asia.

Rethink your export strategy and look beyond the traditional markets

What does all this mean for your growth strategy as a business leader or CEO? One of the most important pieces of advice for companies with international ambitions is to reassess their traditional export markets. For years, the United States and China were the obvious destinations for international growth, but that assumption is beginning to crumble.

The US is imposing ever higher import tariffs to protect its own industry, while China has made huge strides in closing the technological gap and is now exporting high-quality products to Europe itself, while importing fewer goods. De Leus therefore advises entrepreneurs to broaden their horizons and spread their risks. And to take a proactive look at regions with which Europe has recently concluded new trade agreements, such as Canada, Mexico or the Mercosur countries.

The European single market also continues to hold enormous potential. Europe is facing a massive wave of investment to achieve its energy and climate transition, boost its defence spending and expand its AI infrastructure. But doing business in Europe remains unnecessarily complex.

“Despite the single currency, businesses within Europe still too often come up against national regulations and administrative barriers.” Koen De Leus

For example, the costs of exporting services to another EU country are on average twice as high as on the domestic market. Nevertheless, there are also opportunities for agile SMEs, especially now that Europe is working towards a single capital market (Capital Markets Union) to facilitate the financing of cross-border business. Do bear in mind well-intentioned European regulations such as the Single Company Statute or the 28th regime. This is still not law. Work is currently underway to reach a compromise that will allow Member States to make certain choices of their own. The major risk here is that, rather than moving towards a single, unified statute, we are heading for 27 versions of the 28th regime.

Take control of your refinancing and coverage

The second key piece of advice for entrepreneurs focuses on the financing itself: be proactive. Too many companies passively allow the expiry date of their existing loans to approach, only to be surprised by an interest rate that has doubled compared with their initial loan.

"In an environment of structurally higher interest rates, you mustn’t be caught off guard," warns De Leus. "As soon as you notice that interest rates are experiencing a temporary, cyclical dip, that is the perfect time to sit down with your relationship manager. Check whether you can refinance part of your loan or lock in the interest rate for a longer period."

The same applies to the move into those new, unfamiliar export markets. Tapping into new regions entails both commercial and financial risks. By making use of solutions such as factoring, or – for larger companies – bank guarantees and trade finance, at an early stage, you can hedge against the risk of non-payment and maintain that much-needed breathing space in your working capital. In times of volatility, an open, strategic dialogue with your relationship manager is therefore your strongest asset.