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5 factors that could drive interest rates higher

July 16, 2014

| MoneyRates.com Senior Financial Analyst, CFA

Recent employment news suggests that the U.S. economy may finally be sustaining some momentum. That should eventually have an impact on bank rates, but as always, timing is everything.

A stronger economy seems likely to lead to higher interest rates, and you should factor that possibility into financial decisions, such as whether to refinance your mortgage or how long a CD term you should choose. The tricky part is that rates may not react immediately, and not all bank rates will respond to these pressures at the same time.

Anticipating the climb

To help you anticipate changes in bank rates, the following are five keys to look for as events play out:

  1. Continued job growth. Employment growth in June topped 200,000 for the fifth consecutive month. This is a strong sign that the economy has shaken off its first-quarter slump, and the higher demand for capital that comes with a stronger economy should push interest rates higher.
  2. The Fed starting to sell bonds. Over the past several months, the Federal Reserve has been tapering off the bond purchases it has been making to help push long-term interest rates (like mortgage rates) down. However, phasing out the bond purchases is just one stage of unwinding this policy. Ultimately, the Fed will have to sell off at least part of the massive inventory of bonds they accumulated while this policy was in place. Those sales should put upward pressure on interest rates.
  3. Bank lending picking up. As the economy improves, loan volume should pick up, and being able to put more money to productive use should encourage banks to offer higher interest rates to attract deposits.
  4. Depositors finding alternatives. As a function of the above two points, banks may have to offer higher rates simply because depositors will have more attractive alternatives once bond yields start to rise. Banks won't want to see their deposits starting to decline just as their loan business is picking up.
  5. Inflation perking up. A stronger economy could bring higher prices. If inflation perks up, it could accelerate the rise of interest rates, though that may not really benefit depositors if those higher rates are offset by higher prices.

If the above events stay on course, you should consider the following moves:

  1. Make mortgage decisions a priority. For several reasons, mortgage rates are likely to move before deposit rates do. Therefore, if you are considering buying a home or refinancing a mortgage, you should not delay this decision for long.
  2. Switch from long- to medium-term CDs. The rise in bank rates is likely to be a slow one at first, so you can still benefit from higher rates in medium-term rather than short-term CDs, but you may want to avoid long-term commitments unless they come with low early withdrawal penalties.
  3. Compare banks before you commit. Once interest rates start to move, bank reaction is likely to be varied, resulting in widening spreads between the most competitive rates and the average.

After more than five years of super-low interest rates, it is almost hard to imagine that environment changing. However, when such economic events are a long time in coming, the change that results can often be swift and dramatic. Being prepared for the change can help you react appropriately when the time comes.

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