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December Fed update: What latest rate hike means for bank rates

December 16, 2016

By Richard Barrington | MoneyRates.com Senior Financial Analyst, CFA

Bank rates and the Federal Reserve

The Federal Reserve announced its first rate hike since December of 2013 at the conclusion of its latest meeting on Dec. 14. When you only take this kind of action once every three years or so, you can expect it to attract a lot of attention.

The decision to raise its target for short-term interest rates by 0.25 percent to a range between 0.50 and 0.75 percent was a mild policy change and the type of adjustment the Fed used to make all the time. However, since Janet Yellen's Fed has been so reluctant to raise bank rates, even this modest change generated a flurry of reactions.

The media coverage was full of speculation about the impact on consumers and investors. The stock market took a bit of a hit on the announcement, but this may prove to be short-lived. Ultimately, the substantive consequences of the Fed's decision may be muted because the move was so widely anticipated. Consumers should be more wary of the economic conditions leading to the Fed's policy move than of the move itself.

After running below the Fed's target of 2 percent for the past few years, inflation has clearly been picking up the pace in recent months. A recent OPEC agreement to cut oil production could add to inflation pressures. The Fed's move to raise rates simply followed a course much of the financial community had already taken.

Interest rate hike's impact on consumers and bank rates

If you want evidence that much of the financial community does not wait for the Fed to act before adjusting its own assumptions, you need only look at mortgage rates. 30-year rates had already risen by 71 basis points in the nine weeks prior to the Fed meeting.

The reason? Inflation is like Kryptonite to lenders - it diminishes the value of the future interest and principal payments they receive from borrowers. Their defense against inflation is to to raise interest rates, which explains why mortgage rates rose so decisively in advance of the Fed's rate hike.

On the other side of the ledger, there was no such immediate reaction in the interest rates that banks pay on deposits like savings accounts and money market accounts. Unlike most mortgage rates, these bank deposit rates are not locked in for long periods, but can be adjusted at any time. Thus, it is not as important for them to rise in anticipation of upcoming developments. Besides, low deposit rates represent a risk for consumers, not for the banks paying those rates.

For consumers, these signals suggest that any move to apply for or refinance a mortgage should not be delayed. Despite the recent rise, mortgage rates remain unusually low, and continued inflation pressures could push them closer to more normal levels.

As for low deposit rates, rising inflation means they are an even greater problem for consumers. That makes it more important to shop actively for the best bank rates, especially since fast-changing conditions might widen differences between banks.

More from MoneyRates.com:

November Fed update: Fed doesn't act on bank rates - but consumers can

September Fed update: Bank rate increase delay, how consumers can prepare

July Fed update: Is Fed too focused on past econ conditions to raise bank rates

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