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Fed April update: Is door to future bank rate increases opening?

April 27, 2016

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

Federal Reserve and bank rates

While the Federal Reserve decided to stand pat for the third consecutive meeting, the way economic conditions are developing suggests reason to believe the door to future rate increases may start to open.

Economic factors determining bank rate increases

The Fed has consistently reminded people that it is primarily concerned with stabilizing two factors: employment and inflation. The Fed acknowledges that continued job growth means employment has not been a problem recently, leaving inflation as the primary area of concern.

Traditionally, when the Fed had an issue with inflation it has entailed trying to stop inflation from getting out of control. However, since the Great Recession, the Fed has been grappling with the opposite problem: chronically low inflation. The Fed has set an inflation target of 2 percent, and the actual inflation rate has consistently fallen short of that.

Fed keeping an eye on inflation target

While it is easy to understand the traditional concern with keeping inflation from getting too high, this more recent concern with bringing inflation up to a minimum target is not universally embraced. Some maintain that low inflation is a symptom of general economic malaise, but not itself a root cause. Others feel that low inflation is not a problem anyway, because it helps consumers.

However, the view of the Fed and many mainstream economists is that low inflation or deflation is bad for growth because it encourages people to delay purchases. With stable or declining prices, people are in no rush to buy things because they are confident prices will be the same or even lower in the near future.

Whether or not you accept this theory, the reality is that as long as inflation remains below 2 percent, it will be a deterrent to the Fed raising interest rates. Over the past 12 months, inflation has been just 0.9 percent, though this has been largely due to a 12.6 percent decline in the energy sector. However, take out the energy sector and inflation for the past 12 months has been 2 percent - precisely the Fed's target. It seems likely that as energy prices stabilize, overall inflation will start to approach the Fed's target and no longer be an impediment to raising rates.

How the dollar's value affects future rate hikes

One factor whose influence spans both inflation and employment growth is the value of the U.S. dollar relative to other currencies. This influence has generally been working against further rate increases, but lately things have started to change.

In 2014 and 2015, the dollar rose sharply. This can be bad for jobs because it puts the U.S. at a trade disadvantage, and it is also deflationary because it make foreign goods cheaper. A dilemma the Fed has faced is that interest rate increases would likely further boost the value of the dollar.

However, the dollar has been falling since the end of February. This decline, along with stabilizing oil prices, could open the door to Fed rate increases in the months to come.

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