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June Fed update: Bank customers lose as Fed rate policy remains handcuffed

June 17, 2016

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

Federal Reserve and bank rates

While the Federal Reserve took no new action following its meeting June 15, there have been significant developments in the economy that could impact bank rates and customers. In concluding its meeting, the Fed decided to leave the target rate for interest rates between 1/4 and 1/2 percent. This means the Fed made no changes since a modest 1/4 percent rate hike in December 2015.

The major economic trends the Fed focuses on have effectively flipped in recent months, leaving the Fed with a monetary policy dilemma. This also affects consumers with some potential financial problems related to interest rates.

Slow job growth, rising inflation complicate Fed response

The Fed has consistently stated that its primary goals are maintaining a strong job market along with a healthy inflation rate of around 2 percent. Over the past couple years, the job market has done its part by consistently putting up strong employment growth numbers. Inflation, however, has repeatedly fallen short of the Fed's target. Lagging inflation has been the leading reason the Fed has gone slow on raising interest rates despite a strong job market.

Recent months have seen job growth and inflation switch roles: Suddenly, employment is disappointing while inflation is on the rise. It is still too early to tell if the slowdown in job growth is just a temporary hiccup or a new trend, but in the meantime it effectively handcuffs Fed policy. It would be very difficult to justify raising rates while employment seems to be stalling, but if the recovery in oil prices continues, inflation could demand a monetary policy response.

Most people would agree that strong job growth and low inflation was a good problem to have. In contrast, the recent direction of weakening job growth and strengthening inflation is a much stickier problem.

Future impact of Fed policy on bank customers

While the Fed took no action on interest rates in its latest meeting, consumers should still be alert for changes in both mortgage rates and in savings account rates and other bank rates. In fact, the current dynamic of slow employment growth keeping Fed policy in place while inflation seems to be rising could very well work against consumers.

In recent years, the saving grace of low deposit rates was that inflation was also very low, and, in some cases, negative. However, if banks continue to follow the Fed's lead and hold off on raising deposit rates even though inflation has started to rise, bank rates may increasingly slip below the inflation rate. For depositors, this means steadily losing purchasing power on their savings.

Since mortgage rates are less directly influenced by Fed policy than deposit rates, it could push mortgage rates higher even while deposit rates stay near zero, if the upturn in inflation continues.

A widening gap between loan and deposit rates and negative inflation-adjusted deposit rates amount to a double disadvantage resulting from inflation strengthening while job growth is weakening. Consumers - and the Fed - should hope inflation and job growth get a little more in sync in the months ahead.

More from MoneyRates.com:

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

Fed January update: Why did Fed delay further bank rate hike?

Fed December update: Rate change finally - was it worth all the suspense?

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