Higher-than-expected interest rates continue to pressure UK SMEs

Many UK SMEs entered 2026 expecting borrowing costs to ease more quickly than they have.

Higher-than-expected interest rates continue to pressure UK SMEs

Many UK SMEs entered 2026 expecting borrowing costs to ease more quickly than they have. While interest rates have fallen from recent highs, borrowing remains more expensive than many businesses anticipated, continuing to influence investment decisions, cashflow management and growth plans. This comes at a time when businesses are balancing economic and geopolitical uncertainty with a continued focus on growth and resilience.

Interest rate expectations remain uncertain

At the start of the year, there was growing confidence that businesses would benefit from a more significant reduction in borrowing costs during 2026. While the Bank of England has reduced the base rate from recent highs, rates remain elevated compared with the ultra-low borrowing environment many businesses had become accustomed to.

With the base rate currently at 3.75%, borrowing remains considerably more expensive than in the years before inflationary pressures began to accelerate. As a result, many SMEs are finding that anticipated relief on financing costs has not materialised as quickly as expected.

This continued uncertainty is influencing business behaviour, reducing appetite for borrowing and prompting organisations to reassess investment and growth plans.

Higher borrowing costs continue to weigh on investment decisions

For many SMEs, higher borrowing costs are forcing a rethink of investment plans. While debt can support growth – funding expansion, hiring or new projects – the cost is becoming harder to justify. This is leading to a more cautious approach:

Reprioritising investment towards projects with the strongest return
Scaling back growth initiatives
Reassessing the affordability of new borrowing

In more challenging cases, this environment may increase the risk of financial distress, particularly where margins are already under strain.

For many businesses, the challenge is not simply the cost of borrowing. It is understanding how much financial headroom they have available if conditions change further. Rising interest costs, tighter lending conditions and persistent cost pressures can gradually reduce flexibility, leaving businesses with fewer options when opportunities or challenges arise.

Sector impact and wider cost pressures

The impact is being felt across a range of sectors, including manufacturing, logistics and haulage, hospitality and construction. These industries are already facing a combination of rising costs and operational challenges, such as

Increased fuel and energy prices
Higher employer National Insurance contributions
Business rates and wage increases
Ongoing supply chain disruption
Cautious consumer demand

Further pressure has come from rising global shipping costs and delays linked to disruption in key trade routes – particularly affecting businesses reliant on imported goods.

Businesses remain focused on resilience and growth

While higher borrowing costs continue to create challenges, many businesses are adapting rather than standing still. Increasingly, leadership teams are focused on operational agility, careful financial planning and targeted investment that strengthens resilience and supports long-term growth

For many SMEs, the challenge is not whether to invest, but how to allocate capital effectively in a higher-cost environment. Businesses with sufficient financial headroom are often better placed to seize opportunities, invest in expansion, pursue acquisitions or navigate periods of uncertainty without being forced into reactive decisions.

Financing conditions remain challenging

While some SMEs may benefit from legacy pandemic-era borrowing arrangements reaching maturity, the cost of securing new finance remains significantly higher than many businesses anticipated.

Historically low cost of funds of 0.1% or 0.5% are firmly in the past, and today's environment is fundamentally changing how businesses approach debt, investment and cashflow management.

For businesses with variable-rate facilities, borrowing costs remain a significant consideration when evaluating new opportunities, refinancing arrangements or longer-term growth strategies.

Alongside higher borrowing costs, many businesses are also finding that lenders are taking a more cautious approach. Greater scrutiny around affordability, forecasting accuracy and covenant performance means funding conversations can take longer and require more preparation than in previous years.

Building resilience in a higher-cost environment

In this environment, financial discipline and forward planning are critical. Businesses should take a step back to fully understand their financial position – including cashflow, affordability and resilience under different scenarios.

Key actions include:

Reviewing cashflow forecasts and funding requirements
Stress‑testing financial plans against higher borrowing costs
Understanding existing debt structures and exposure to rate changes
Engaging early with advisers or lenders

Timing matters. Businesses that review funding arrangements well ahead of refinancing deadlines often have more options, stronger negotiating positions and greater control over outcomes.

Balancing caution with opportunity

While uncertainty is likely to persist, taking early, informed decisions can help businesses manage risk and retain control.

Seeking advice early can make a meaningful difference – whether planning for growth or navigating financial pressure. Having a clear view of your options puts you in a stronger position to respond.

The businesses best positioned to thrive over the coming years are likely to be those that proactively assess their funding arrangements, understand the level of headroom available to them and take action before pressure builds.

Get in touch

Mark Barrie

Head of Debt Advisory

Hertford

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