What does an inverted yield curve mean for business loans?

Short-term rates sit above longer-term ones, so a floating-rate loan can cost more today than a fixed one for the same borrower. It does not mean that fixing is automatically the better deal: the curve has already priced lower floating rates ahead. For a lender, an inversion is a reason to test what happens to a borrower's cash flow if the slowdown the market expects arrives, and to check which facilities come up for refinancing while rates are unsettled.

Who sets the yield curve?

No single body. A central bank sets the overnight policy rate, which anchors the very short end. Longer rates come from buying and selling in bond and swap markets, where investors, banks and borrowers act on their views about future policy, inflation and risk. A central bank can influence the longer end by what it signals or by buying bonds, but the curve on any given day is a market price rather than a decision.

What is the difference between a yield curve and a swap curve?

A yield curve is the general term: rates plotted against maturity, and in the news it usually means government bonds. A swap curve is one version built from interest rate swaps, the fixed rate exchanged for a floating benchmark over each term. The two differ by the swap spread, which reflects bank credit and market supply and demand. Corporate loans are usually priced from the swap curve, since that is where a bank's hedging is done.

Does an inverted yield curve predict a recession?

It has often preceded one, most consistently in United States data, but it is a signal rather than a forecast with a date. The lag has varied by many months, and shapes on other countries' curves can reflect local conditions or moves in global rates. A central bank that is holding short rates high to fight inflation can invert the curve without a recession following. A lender reads an inversion as a prompt to stress its book.

// WORKED EXAMPLETHE ARITHMETIC A DECISION RESTS ON

Yield Curve: a Worked Example for a Borrower

Today's price of money, quoted for every year ahead.

BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED 2026-11-09 · 6 MIN READ

// THE SHORT ANSWER

Every fixed-rate quote a business receives was read off a yield curve. The curve shows what the market charges today for money over different terms, so its shape says two things at once: what a five-year fixed rate costs before the bank adds its margin, and where the market thinks short rates are going. A lender uses both. It prices the fixed loan off the curve, and it can test a floating-rate borrower at rates the curve implies as well as the rate on today's statement. The shape is a price and a forecast, and neither is a promise.

BASIS Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.

// MAKE THE CALL

Issue 09 — The Tuesday List. Eight dashboards. Two intensive-care slots. Portfolio triage, Tuesday 8:30am. Your call first, then the senior banker's.

Read the file →

PART OF What Is Corporate Banking?

// 01 — WHAT THE CURVE IS AND WHY IT SLOPES

Plot interest rates against time, from overnight to ten years or more, and the line is the curve. The central bank's policy rate anchors the short end. Everything further out is set by trades in the market. Two forces shape it: what investors expect short rates to do over the term, and a term premium, the extra they want for locking money up while rates or inflation might move.

When the premium and expectations both point up, the curve slopes upward, the shape often seen in an expansion. If investors expect the policy rate to fall, longer rates can sit below shorter ones and the curve inverts. Between them are flat curves and humped ones, where the middle sits above both ends.

Two curves are in daily use. The government bond curve is the market's reference for sovereign borrowing and the one quoted in the news. The swap curve is built from interest rate swaps and is usually the one a bank prices a fixed-rate loan from.

// 02 — HOW A LOAN IS PRICED OFF IT

Floating rate = base rate (resets each period) + margin

Fixed rate = swap rate for the term + margin

Forward rate, year 1 to year 2 = (1 + r2)² ÷ (1 + r1) − 1

The base rate is the short end of the curve for the local currency. In New Zealand it is commonly BKBM, the bank bill benchmark; in Australia, BBSW; in the UK, SONIA, an overnight rate compounded over the interest period. Some smaller loans are priced off a bank's own published rate or a central bank's policy rate instead. The fixed rate comes from further along the curve, because the bank can swap or fund the fixed period at that rate. The margin on top is the bank's own and is covered in how banks price a business loan.

The forward rate is what the curve implies for a period starting in the future. It is arithmetic, and it includes the term premium, so it is not a pure forecast. It is still the market's price for that future period, and a lender can use it as one reasonable path for the rate.

// 03 — THE EXAMPLE

A chain of laundrettes, constructed for this page like every figure in it, borrows US$12m for five years at a margin of 2.40 points. Its EBITDA is US$2.6m. Two versions of the market, on rates that are the example's and not a forecast:

Base 1 yr 2 yr 5 yr

Upward 3.40% 3.50% 3.80% 4.25%

Inverted 5.10% 5.00% 4.50% 4.00%

Rate First-year interest

Upward, floating 5.80% US$696,000

Upward, fixed five years 6.65% US$798,000

Inverted, floating 7.50% US$900,000

Inverted, fixed five years 6.40% US$768,000

Forward for year 2

Upward: (1.038² ÷ 1.035) − 1 = 4.10% + 2.40 = 6.50%

Inverted: (1.045² ÷ 1.05) − 1 = 4.00% + 2.40 = 6.40%

On the upward curve, fixing costs US$102,000 more in the first year. That is not free money for the bank: the curve has priced floating rates to rise, and by year 2 the implied floating cost of 6.50% is most of the way to the 6.65% fixed. On the inverted curve, fixing saves US$132,000 in the first year, but the curve has priced floating rates to fall, and the implied year-2 cost of 6.40% is level with the fixed rate. The first-year comparison says little by itself. Whichever the borrower chooses, it gains only if rates differ from what the curve already priced.

A lender reads the cover the same way. On the upward curve, interest cover is 3.74 times at today's floating rate (2.6 ÷ 0.696) and 3.33 times at the implied year-2 rate (2.6 ÷ 0.78). The file records both, and often a stressed rate above them.

// 04 — HOW IT DIFFERS FROM THE POLICY RATE

A central bank sets one point on the curve, the overnight rate. The rest is the market's. A rate cut can leave five-year rates unchanged, or push them up if investors fear inflation, and a five-year fixed quote can move on a day when no central bank has done anything. How an interest rate change reaches you follows that path to a borrower.

An inverted curve is the most quoted reading. The Reserve Bank of Australia describes the slope as a leading indicator of growth and inflation, and notes that in some countries, the United States among them, inversion has historically come before contractions. Which maturities are inverted matters, and it gives no date. A lender treats it as a prompt to look at the book.

DEFINED IN ONE PARAGRAPH → · AN INTEREST RATE SWAP → · FIXED OR FLOATING →

// 05 — WHERE IT DECIDES A FILE

The curve enters a file in four places. It sets the cost of any hedging condition on the loan, and the tenor of that hedge is read against the debt it protects. It informs the rates at which floating-rate debt is tested for serviceability. It decides what the borrower pays to leave a fixed rate early: if the curve has fallen since the rate was struck, there is a break cost, the swap mark-to-market in loan form. And it describes the market the loan will refinance in.

It also runs through the lender's own earnings. A bank that funds short and lends long gains from a steeper curve and is squeezed by a flat or inverted one, unless it has hedged, which is why a change in the slope can appear in its appetite and in its net interest margin.

NET INTEREST MARGIN → · HEDGING POLICY →

// SOURCES

The documents the statements on this page rest on. Each was opened and checked when cited.

Reserve Bank of Australia, Explainer: Bonds and the Yield Curve — Defines the curve, links long yields to expected policy rates and a term premium, and describes the slope as a leading indicator with the United States pattern noted — sections 01 and 04.
Bank of England, SONIA benchmark — The Bank is the administrator of SONIA, which reflects the average overnight rate banks pay to borrow sterling — section 02.
Financial Markets Authority (New Zealand), Bank Bill Benchmark Rate and closing rates, October 2017 — Describes BKBM as New Zealand's main interest rate benchmark — section 02.

// QUESTIONS PEOPLE ASK

What does an inverted yield curve mean for business loans?: Short-term rates sit above longer-term ones, so a floating-rate loan can cost more today than a fixed one for the same borrower. It does not mean that fixing is automatically the better deal: the curve has already priced lower floating rates ahead. For a lender, an inversion is a reason to test what happens to a borrower's cash flow if the slowdown the market expects arrives, and to check which facilities come up for refinancing while rates are unsettled.
Who sets the yield curve?: No single body. A central bank sets the overnight policy rate, which anchors the very short end. Longer rates come from buying and selling in bond and swap markets, where investors, banks and borrowers act on their views about future policy, inflation and risk. A central bank can influence the longer end by what it signals or by buying bonds, but the curve on any given day is a market price rather than a decision.
What is the difference between a yield curve and a swap curve?: A yield curve is the general term: rates plotted against maturity, and in the news it usually means government bonds. A swap curve is one version built from interest rate swaps, the fixed rate exchanged for a floating benchmark over each term. The two differ by the swap spread, which reflects bank credit and market supply and demand. Corporate loans are usually priced from the swap curve, since that is where a bank's hedging is done.
Does an inverted yield curve predict a recession?: It has often preceded one, most consistently in United States data, but it is a signal rather than a forecast with a date. The lag has varied by many months, and shapes on other countries' curves can reflect local conditions or moves in global rates. A central bank that is holding short rates high to fight inflation can invert the curve without a recession following. A lender reads an inversion as a prompt to stress its book.

// NEXT TO IT

// ON WHOSE DESK

The seats that read this term in an ordinary week. Each page says what the seat is for, who arrives in it, and the shape of the round it runs.

Regulatory reporting analystProduces the returns the bank's regulator relies on — capital, liquidity, large exposures, credit quality.
Treasury analystFunds the bank and manages the interest rate and liquidity risk created by its own balance sheet.
Financial accountantProduces and stands behind the bank's own numbers — the ledger, the close, the statutory accounts.

THE IN-TRAY · ONE MINUTE

Make the call on one file.

A short file on the ground this page covers. Every option opens with how far it sits from a senior banker’s read.

WHAT THEY HEAR · THE BANK · FUNDING AND LIQUIDITY

A bank treasurer tells the credit committee: 'Deposits grew nicely this quarter — mostly from a few large corporate customers.'

What should the committee hear?

3 MORE ON THE BANK · FUNDING AND LIQUIDITY →WHERE DO YOU READ FROM? THE PLACEMENT →

THE READING ROOMIN ONE PARAGRAPHYield curve What does the yield curve tell a lender?