The Federal Reserve's decision to raise interest rates by another quarter point on Wednesday has sparked debate among economists and market watchers. The move marks the Fed's 10th consecutive rate hike and is aimed at reducing inflation, which remains higher than the target rate of 2%. However, opponents argue that inflation is already showing signs of slowing, and further rate increases could harm small businesses and lead to increased unemployment. The recent failure of mid-size bank First Republic Bank has added to concerns that another rate hike could contribute to a recession. The Fed defends the move by noting the need to balance the risk of not doing enough against the risk of slowing down economic activity too much.
The Federal Reserve reinforced its fight against high inflation Wednesday by raising its key interest rate by a quarter-point to the highest level in 16 years. But the Fed also signaled that it may now pause its streak of 10 rate hikes, which have made borrowing for consumers and businesses steadily more expensive.
In a statement after its latest policy meeting, the Fed removed a sentence from its previous statement that had said “some additional” rate hikes might be needed. It replaced it with language that said it will now weigh a range of factors in “determining the extent” to which future hikes might be needed.
Speaking at a news conference, Chair Jerome Powell said the Fed has yet to decide whether to suspend its rate hikes. But he pointed to the change in the statement’s language as confirming at least that possibility.
Having raised their key short-term rate by a substantial 5 percentage points since March 2022, Powell said, Fed officials can step back and assess the impact of higher rates on growth and inflation. He said the Fed would also monitor other factors, including the turmoil in the banking sector, to determine whether to pause its rate hikes. In doing so, he said, the central bank would set its rate policy on a meeting-to-meeting basis.
The Fed chair stressed his belief that the collapse of three large banks in the past six weeks will likely cause other banks to tighten lending to avoid similar fates. Such lending cutbacks, he added, will likely help slow the economy, cool inflation and lessen the need for the Fed to further raise rates.
When asked whether the Fed’s key rate was now high enough to restrain the economy and curb inflation, Powell said, “We may not be far off — or possibly even at that level.”
James Knightley, chief international economist at ING, suggested that “with lending conditions rapidly tightening in the wake of recent bank stresses, we think this will mark the peak for interest rates.”
Still, if inflation were to accelerate, the Fed “won’t hesitate to resume hiking interest rates because they’re determined to break inflation’s back,” said Ryan Sweet, chief economist at Oxford Economics. “As such, there is a risk that the pause is temporary.”
The Fed’s rate increases since March 2022 have more than doubled mortgage rates, elevated the costs of auto loans, credit card borrowing and business loans and heightened the risk of a recession. Home sales have plunged as a result. The Fed’s latest move, which raised its benchmark rate to roughly 5.1%, could further increase borrowing costs.
In its statement and at Powell’s news conference, the Fed made clear Wednesday that it doesn’t think its string of rate hikes have so far sufficiently cooled the economy, the job market and inflation. Inflation has dropped from a peak of 9.1% in June to 5% in March but remains well above the Fed’s 2% target rate.
“Inflation pressures continue to run high, and the process of getting getting inflation back down to 2% has a long way to go,” Powell said.
The three banks that collapsed had bought long-term bonds that paid low rates and then rapidly lost value as the Fed sent rates higher. At his news conference, Powell noted that a Fed survey found that mid-sized banks were already tightening credit before the banking upheavals and have done so even more since the failures.
Fed economists have estimated that tighter credit resulting from the bank failures will contribute to a “mild recession” later this year, thereby raising the pressure on the central bank to suspend its rate hikes.
Even if the Fed imposes no further increases, many economists have said they expect the central bank to keep its benchmark rate at its peak for a prolonged period, likely through year’s end.
The Fed is now also grappling with a standoff around the nation’s borrowing limit, which caps how much debt the government can issue. Congressional Republicans are demanding steep spending cuts as the price of agreeing to lift the nation’s borrowing cap.
Earlier this week, Treasury Secretary Janet Yellen warned that the nation could default on its debt as soon as June 1 unless Congress agreed to lift the federal borrowing limit. A first-ever default on the U.S. debt could potentially lead to a global financial crisis.
Powell reiterated his warning that “no one should assume that the Fed can protect the economy from the potential short and long-term effects of a failure to pay our bills on time.”
The Fed’s decision Wednesday came against an increasingly cloudy backdrop. The economy appears to be cooling, with consumer spending flat in February and March, indicating that many shoppers have grown cautious in the face of higher prices and borrowing costs. Manufacturing, too, is weakening.
Even the surprisingly resilient job market, which has kept the unemployment rate near 50-year lows for months, is showing cracks. Hiring has decelerated, job postings have declined and fewer people are quitting jobs for other, typically higher-paying positions.
Goldman Sachs estimates that a widespread pullback in bank lending could cut U.S. growth by 0.4 percentage point this year. That could be enough to cause a recession. In December, the Fed projected growth of just 0.5% in 2023.
The Fed’s latest rate hike comes as other major central banks are also tightening credit. European Central Bank President Christine Lagarde is expected to announce another interest rate increase Thursday after inflation figures released Tuesday showed that price increases ticked up last month.
Consumer prices rose 7% in the 20 countries that use the euro currency in April from a year earlier, up from a 6.9% year-over-year increase in March.
In the U.S., several factors are slowing inflation. The rise in rental costs has eased as more newly built apartments have come online. Gas and energy prices have fallen. Food costs are moderating. Supply chain snarls are no longer blocking trade, thereby lowering the cost for new and used cars, furniture and appliances.
Still, while overall inflation has cooled, “core” inflation — which excludes volatile food and energy costs — has remained chronically high. According to the Fed’s preferred measure, core prices rose 4.6% in March from a year earlier, scarcely better than the 4.7% it reached in July.
The Federal Reserve has raised its key interest rate yet again in its drive to cool inflation, a move that will directly affect most Americans.
On Wednesday, the central bank boosted its benchmark rate by a quarter-point to 5.1%. Rates on credit cards, mortgages and auto loans, which have been surging since the Fed began raising rates last year, all stand to rise even more. The result will be more burdensome loan costs for both consumers and businesses.
On the other hand, many banks are now offering higher rates on savings accounts, giving savers the opportunity to earn more interest.
Economists worry, though, that the Fed’s streak of 10 rate hikes since March 2022 could eventually cause the economy to slow too much and cause a recession.
Here’s what to know:
WHAT’S PROMPTING THE RATE INCREASES?
The short answer: inflation. Inflation has been slowing in recent months, but it’s still high. Measured over a year earlier, consumer prices were up 5% in March, down sharply from February’s 6% year-over-year increase.
The Fed’s goal is to slow consumer spending, thereby reducing demand for homes, cars and other goods and services, eventually cooling the economy and lowering prices.
Fed Chair Jerome Powell has acknowledged in the past that aggressively raising rates would bring “some pain” for households but said that doing so is necessary to crush high inflation.
WHO IS MOST AFFECTED?
Anyone borrowing money to make a large purchase, such as a home, car or large appliance, will likely take a hit. The new rate will also increase monthly payments and costs for any consumer who is already paying interest on credit card debt.
“Consumers should focus on building up emergency savings and paying down debt,” said Greg McBride, Bankrate.com’s chief financial analyst. “Even if this proves to be the final Fed rate hike, interest rates are still high and will remain that way.”
WHAT’S HAPPENING WITH CREDIT CARDS?
Even before the Fed’s latest move, credit card borrowing had reached the highest level since 1996, according to Bankrate.com.
The most recent data available showed that 46% of people were carrying debt from month to month, up from 39% a year ago. Total credit card balances were $986 billion in the fourth quarter of 2022, according to the Fed, a record high, though that amount isn’t adjusted for inflation.
For those who don’t qualify for low-rate credit cards because of weak credit scores, the higher interest rates are already affecting their balances.
HOW WILL AN INCREASE AFFECT CREDIT CARD RATES?
The Fed doesn’t directly dictate how much interest you pay on your credit card debt. But the Fed’s rate is the basis for your bank’s prime rate. In combination with other factors, such as your credit score, the prime rate helps determine the Annual Percentage Rate, or APR, on your credit card.
The latest increase will likely raise the APR on your credit card 0.25%. So, if you have a 20.9% rate, which is the average according to the Fed’s data, it might increase to 21.15%.
If you don’t carry a balance from month to month, the APR is less important.
But suppose you have a $4,000 credit balance and your interest rate is 20%. If you made only a fixed payment of $110 per month, it would take you a bit under five years to pay off your credit card debt, and you would pay about $2,200 in interest.
If your APR increased by a percentage point, paying off your balance would take two months longer and cost an additional $215.
WHAT IF I HAVE MONEY TO SAVE?
After years of paying low rates for savers, some banks are finally offering better interest on deposits. Though the increases may seem small, compounding interest adds up over the years.
Interest on savings accounts doesn’t always track what the Fed does. But as rates have continued to rise, some banks have improved their terms for savers as well. Even if you’re only keeping modest savings in your bank account, you could make more significant gains over the long term by finding an account with a better rate.
While the biggest national banks have yet to dramatically change the rates on their savings accounts (clocking in at an average of just 0.23%, according to Bankrate), some mid-size and smaller banks have made changes more in line with the Fed’s moves.
Online banks in particular — which save money by not having brick-and-mortar branches and associated expenses — are now offering savings accounts with annual percentage yields of between 3% and 4%, or even higher, as well as 4% or higher on one-year Certificates of Deposit (CDs). Some promotional rates can reach as high as 5%.
WILL THIS AFFECT HOME OWNERSHIP?
Last week, mortgage buyer Freddie Mac reported that the average rate on the benchmark 30-year mortgage edged up to 6.43% from 6.39% the week prior. A year ago, the average rate was lower: 5.10%. Higher rates can add hundreds of dollars a month to mortgage payments.
Rates for 30-year mortgages usually track the moves in the 10-year Treasury yield. Rates can also be influenced by investors’ expectations for future inflation, global demand for U.S. Treasuries and what the Fed does.
Most mortgages last for decades, so if you already have a mortgage, you won’t be impacted. But if you’re looking to buy and already paying more for food, gas and other necessities, a higher mortgage rate could put home ownership out of reach.
WHAT IF I WANT TO BUY A CAR?
With shortages of computer chips and other parts easing, automakers are producing more vehicles. Many are even reducing prices or offering limited discounts. But rising loan rates and lower used-vehicle trade-in values have erased much of the savings on monthly payments.
Since the Fed began raising rates in March 2022, the average new-vehicle loan rate has jumped from 4.5% to 7%, according to Edmunds data. Used vehicle loans dropped slightly to 11.1%. Loan durations average around 70 months — nearly six years — for new and used vehicles.
Largely because of rate increases, the average monthly payment for both new and used vehicles has risen since March 2022, Edmunds says. The average new vehicle payment is up $72 to $729, Edmunds says. For used vehicles, the payment rose $20 a month to $546.
The higher rates will keep out of the market people who have the ability to wait for more favorable terms, said Joseph Yoon, Edmunds’ consumer insights analyst.
“But with inventory levels improving, it’s a matter of time before discounts and incentives start coming back into the equation,” attracting more buyers, Yoon said.
New vehicle average prices are down from the end of last year to $47,749. But they’re still high compared with even a year ago. The average used vehicle price dropped 7% from last May’s peak, to $28,729, but prices are edging back up.
Financing a new vehicle now costs $8,655 in interest. Analysts say that’s enough to chase many out of the auto market.
Any Fed rate increase is typically passed through to auto borrowers, though it will be offset a bit by subsidized rates from manufacturers.
WHAT ABOUT MY JOB?
The nation’s employers kept hiring in March, adding a healthy 236,000 jobs. The unemployment rate fell to 3.5%, just above the 53-year low of 3.4% set in January. At the same time, the report from the Labor Department suggested a slowdown, with pay growth also easing.
Some economists argue that layoffs could help slow rising prices, and that a tight labor market fuels wage growth and higher inflation.
Economists expect the unemployment rate to go up to 3.6% in April, a slight increase from January’s half-century low of 3.4%.
WILL THIS AFFECT STUDENT LOANS?
Borrowers who take out new private student loans should prepare to pay more as as rates increase. The current range for federal loans is between about 5% and 7.5%.
That said, payments on federal student loans are suspended with zero interest until summer 2023 as part of an emergency measure put in place early in the pandemic. President Joe Biden has also announced some loan forgiveness, of up to $10,000 for most borrowers, and up to $20,000 for Pell Grant recipients — a policy that’s now being challenged in the courts.