Announcement: Moody's: Rising interest rates are unlikely to hurt European companies' profits, cash flows in the medium term

Rising interest rates in Europe are unlikely to hurt companies' profits and cash flows in the medium term, in spite of the potential for them to dampen consumer confidence, says Moody's Investors Service in a report published today. The rate increases are expected to be very gradual and to coincide with strong economic growth and employment rates, leading to a more positive impact on corporate profitability and investment strategies.

Moody's forecasts the policy rates to approach 1% for the European Central Bank (ECB), 2% for Bank of England (BoE) and 3% for the US Federal Reserve by 2021.

"While the overall impact of interest rate rises will likely be negligible for most European companies, the impact of rising borrowing costs would be more obvious for speculative-grade firms, which are often smaller and less diversified than their investment-grade peers, and have weaker credit metrics and higher interest costs relative to earnings," says Richard Morawetz, Moody's Senior Credit Officer for the Corporate Finance Group and author of the report.

Interest rate rises could coincide with a tapering of central bank asset purchases but Moody's expects the impact of the latter on borrowing costs to be limited. The ECB tapering is expected to be gradual, and it remains committed to buying assets until at least September 2018, and thereafter if necessary. In addition, the majority of euro area corporate debt funding emanates from banks, which lessens the overall impact of ECB purchases on borrowing costs.

Corporate pension liabilities could benefit from rising interest rates by reducing the present value of future lease payments but this gain could be tempered if they also result in lower pension asset values. For the 20 rated European companies that had the highest pension adjustments in 2016, the most recent reports indicate that the aggregate pension and other post retirement liabilities have fallen by about 11% in euro terms. This should have a positive effect on their 2017 credit metrics, although in many cases it comes after a notable hike in their pension deficits and a fall in discount rates in 2016 .

Rising interest rates could also reduce the IFRS 16 lease liability for many companies when they adopt the new accounting standard in 2019. The new standard will require companies to report the present value of nearly all their future lease payments as an on-balance sheet liability, contrary to previous reporting requirements.