With inflation raging at near or above multi-year peaks, major central banks are signaling unmistakably that higher interest rates are on the way. In some major economies, monetary policy has already tightened.
The US Federal Reserve is widely expected to make its first hike in March with more thereafter, following hawkish comments from Chair Jay Powell at the central bank’s last meeting in January. The Bank of England increased the cost of borrowing from 0.25% to 0.5% in February. Christine Lagarde, the European Central Bank’s president, is talking down rate rises, amid fears about the impact on shakier sovereign borrowers like Italy and Greece. But financial markets have priced in an interest rate rise in June.
The repercussions for corporates are likely to be very significant, as the cost of borrowing rises across the economy, calling for financial prudence.
The era of ultra-loose monetary policy prompted a surge in corporate borrowing. Some has been to finance and accelerate growth and investment, whether in a productive capacity or research and development. But ultra-cheap money has spurred some questionable developments.
Mergers and acquisitions have flourished, pointing to higher levels of risk-taking as boardrooms regained their animal spirits after the initial pandemic shock had subsided. And with historically high asset valuations, pushed up by competition, there is a risk that acquisitive companies are overpaying for their targets.
The message for CEOs is clear: be willing to walk away from targets with sky-high multiples. Do not let your egos or desire for empire-building cloud your judgment. Data shows that M&A deals are often only beneficial for the target. In times like these, with increasing debt costs and sky-high valuations, the downside risks for acquirers are magnified. That’s why CFOs facing significantly higher costs of capital are likely to set much higher hurdles for investments and acquisitions, tweaking their models to ensure adequate returns.
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