Bank Rates May Rise As 3 Changing Conditions Take Hold

Three Possible Tipping Points for Bank Rates

For more than a year now, interest rates have been extraordinarily low, and just when you thought they couldn't get any lower, they fell further still. Logically, interest rates cannot continue falling indefinitely, but what will turn them around?

There are actually three possible tipping points for bank rates in the current economic mix. Any or all of these could help turn interest rates around and send them back upward. Whether that's good news or bad news depends on how you use interest rates.

Three Chances to Turn Bank Rates Around

What are the three tipping points that could turn bank rates around? Here are the current possibilities:

• An improving economy. As a general rule of thumb, interest rates tend to fall in recessions, and rise during economic expansions. In mid-September, Federal Reserve Board Chairman Ben Bernanke said that the recession was probably already over, and many commentators agree that at the very least, the worst is over. Now, this does not necessarily mean a boost for interest rates--historically, interest rates have risen on average after a recession, but far from every time. However, there are reasons to expect rates to rise this time around--in particular, because the government has taken extraordinary steps to keep interest rates low to stimulate the economy, and it cannot afford to maintain these measures indefinitely.
• Inflation. Inflation tends to rise as the economy heats up, and at the very least, there are signs that the spate of deflation the U.S. has experienced may already be ending. While the Consumer Price Index did decline by 1.5% for the 12-month period ending in August, most of this decline took place in late 2008. More recently, inflation has been positive in three of the last four months. When inflation exists, interest rates generally rise to keep up.
• Housing prices. Before May of this year, the S&P/Case-Shiller Index had declined for 33 consecutive months, but the two most recent releases showed rising housing prices. Two months' worth of data do not constitute a trend, but since the Case-Shiller Index is based on a three-month moving average of data, the reversal in housing prices may at least be a little better established than two months' of data would suggest. Rising housing prices represent more demand for capital, and thus bring upward pressure on interest rates.

Good News or Bad News for Bank Rates?           

There are three possibilities for moving bank rates higher in the months ahead. Is this good news or bad news? The answer depends on which side of the saver/borrower divide you are on.

If you are a saver, your goal is getting the most out of things like savings account rates and CD rates. With that being the case, you are rooting wholeheartedly for rising interest rates. If you believe some or all of the above factors will move interest rates, you may want to avoid locking in at today's CD rates, since savings account rates will rise more fluidly if market rates start to rise.

If you are a potential borrower, of course, rising interest rates are not good news. However, if you are contemplating a major purchase like buying a home, you can avoid the possibility of rising bank rates by locking into a fixed rate loan now.

 

Source:

Stephen Lebaton • Fed Chief Says Recession Is 'Very Likely Over' • Sep 15, 2009 • The New York Times: http://www.nytimes.com/2009/09/16/business/economy/16bernanke.html?_r=1&scp=1&sq=+bernanke%20+recession&st=cse

• Bureau of Labor Statistics: http://www.bls.gov/news.release/cpi.nr0.htm

• Standard & Poors: http://www2.standardandpoors.com/spf/pdf/index/CSHomePrice_History_082562.xls

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