SME Economic Outlook and Strategic Considerations Summer 2025

SME Economic Outlook and Strategic Considerations | Summer 2025

Executive Summary

The U.S. economy continues to grow in mid-2025, though at a slower pace. Gains In payroll employment are moderating, labor force participation is edging down, and wage growth is sustaining cost pressures. Inflation has eased from its peak but remains above the Federal Reserve’s 2% target, in part due to persistent wage increases. Elevated interest rates and tariff uncertainty are further shaping the outlook.

For small and medium-sized enterprises (SMEs), these dynamics translate into tighter margins, higher borrowing costs, and shifting demand—but also selective opportunities in domestic substitution, technology adoption, and talent acquisition.

Key insights

• Labor: Labor force participation has declined, unemployment remains historically low, and wages are rising at nearly 4% YoY.

• Inflation: Energy relief is offset by wage-driven cost stickiness in housing and services.

• Interest rates: The Fed is holding rates steady, prolonging expensive credit conditions in order to reduce inflation.

• Trade: Tariffs are pushing input costs higher but creating openings for U.S. producers.

1. Macroeconomic Landscape

Labor Market

• Nonfarm payroll employment rose 73,000 in July, led by healthcare (+55,000) and social assistance (+18,000); federal employment declined (-12,000).

• Unemployment stands at 4.2%, low by historical standards, despite slowing job creation.

• The labor force participation rate has slipped to 62.2%, reflecting demographic pressures and skill mismatches (Figure 2).

• Average hourly earnings increased 3.9% YoY, maintaining wage-driven cost pressures.

Implications for SMEs

• Hiring conditions are slightly looser than in 2022–23, but the declining participation rate indicates ongoing competition for skilled workers.

• Elevated wages are increasing payroll costs and feeding directly into service-sector inflation.

• Talent retention is becoming as important as talent acquisition to manage cost dynamics.

Inflation

• Headline CPI rose 0.2% in July, up 2.7% YoY (Figure 3).

• Energy prices fell (-1.1%), lowering transport and utility costs.

• Core CPI remains at 3.1% YoY, with housing, services, and labor costs as persistent drivers.

• Wage growth of nearly 4% YoY is a primary contributor to sticky inflation in service industries (Figure 4).

Implications for SMEs

• Input cost relief from energy is temporary and uneven across industries.

• Wage-driven inflation increases costs in labor-intensive sectors such as hospitality, healthcare, and professional services.

• Businesses with limited pricing power may face sustained margin pressure.

Monetary Policy and Rates

• The Federal Funds Rate remains at 4.25–4.50%.

• The Fed’s pause reflects progress on inflation but ongoing concerns about wage-driven stickiness.

• Business sentiment surveys indicate declining confidence, with many firms delaying expansion plans.

Implications for SMEs

• Borrowing remains costly; refinancing risk is elevated.

• Growth strategies must account for higher financing costs and more selective capital allocation.

• Firms with stronger liquidity and fixed-rate debt structures will be better positioned.

2. Tariffs and Trade Policy

How tariffs impact SMEs

• Cost pressure: Higher input prices for import-dependent sectors.

• Competitive dynamics: Opportunities for domestic suppliers in tariff-protected industries.

• Global reach: Stronger dollar and retaliatory measures reduce export competitiveness.

• Supply chain disruption: Increased volatility in sourcing and pricing.

Current climate

• SMEs in import-reliant industries face higher costs.

• U.S.-based suppliers are seeing opportunities in protected markets.

• Uncertainty complicates long-term investment and procurement decisions.

3. Risks and Opportunities for SMEs

Risks

• Slowing job growth signals softer consumer demand.

• Wage-driven inflation sustains service and rental cost pressures.

• Expensive credit constrains expansion and investment.

• Tariff volatility disrupts supply chains and raises input prices.

Opportunities

• Domestic substitution: Firms competing with imports may capture additional demand.

• Energy reprieve: Lower fuel costs provide near-term savings in logistics.

• Talent access: Easing labor shortages create opportunities to recruit.

• Productivity gains: Technology adoption can offset wage and inflation pressures.

4. Strategic Priorities for SMEs

1. Run Scenario Analyses

   • Model financial outcomes under varying wage, inflation, and interest rate paths.

2. Diversify Supply Chains

   • Reduce reliance on tariff-affected imports; explore nearshoring and local sourcing.

3. Reassess Pricing and Margin Strategy

   • Balance cost pass-through with market competitiveness; closely monitor peers’ responses.

4. Strengthen Liquidity

   • Build cash buffers.

5. Prioritize Workforce Retention

   • Invest in training and retention to contain wage-driven costs; retention is cheaper than replacement.

6. Accelerate Digital Transformation

   • Use automation and AI to offset labor costs and drive efficiency.

Conclusion

Mid-2025 presents SMEs with a challenging but navigable environment. Slowing growth, declining participation, and wage-driven inflation underpin a “higher-for-longer” rate regime. Tariff uncertainty adds complexity, but also openings for domestic players. SMEs that integrate scenario planning, strengthen financial resilience, and invest in talent and technology will be best positioned to turn headwinds into opportunities.

References

• Bureau of Labor Statistics (2025). Employment Situation – July 2025.

• Bureau of Labor Statistics (2025). Consumer Price Index – July 2025.

• Powell, J.H. (2025). Semiannual Monetary Policy Report to the Congress.

• FRED: Federal Reserve Economic Data

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