The highest interest rates in years will complicate farm finances, and operators should expect higher rates to persist for several years as part of efforts to quash inflation, said a team of agricultural economists on Wednesday. Farmers will pay more when they borrow money, face higher break-even levels on investments, and feel downward pressure on the value of farmland, their largest asset.
“While these impacts will make the business of agriculture more difficult, rising interest rates will only present severe issues to a small number of agriculture firms,” said the economists, writing at the farmdoc daily blog. “The extent of the financial stress created for the industry will depend on how high interest rates increase in the future and how long they remain at elevated levels.”
The Federal Reserve raised interest rates repeatedly last year to combat high inflation; the annual inflation rate was 7.1% at latest count. At the end of 2022, the federal funds rate, the overnight lending rate among banks, was 4.33%, “with the prospects of more increases into 2023,” said agricultural economists Gary Schnitkey and Nick Paulson of the University of Illinois and Carl Zulauf of Ohio State. The sharp increases ended a period of low interest rates that began during the Great Recession and was reinstituted during the pandemic.
“Overall, farmers should expect higher interest rates than existed from 2008 to 2021” and plan accordingly, said the three economists. As an example, they said an inflation rate of 2 to 4% a year would suggest a 10-year Treasury bond rate of 4 to 6% and interest rates of 7 to 9% on agricultural debt.
The Federal Reserve has a goal of limiting inflation to 2% annually over the long run. At present, the USDA’s 10-year agricultural baseline assumes a bank prime rate of 6.6% this year and running at 5.1% in all but one of the following years. The prime rate is the interest rate that banks charge their most creditworthy customers and is the foundation for the interest charged on loans, credit cards, and lines of credit.
An increase of 3 percentage points, to 8%, on the rate charged on an operating loan of $800 an acre would add $12 an acre to corn production costs, wrote Schnitkey, Paulson, and Zulauf. Similarly, a 3-point increase would add $28 an acre to the break-even point for installing a tile line that costs $1,000 an acre.
“Higher interest rates generally lead to lower asset values,” said the economists. While farmland values could be affected, there are countervailing factors, including robust returns on farmland and judgments by investors that land is a better hedge against inflation than financial assets. “A large decline in farmland prices in 2023 is not likely,” they said.