For the second time in its last three meetings, the Federal Reserve has decided to raise short-term interest rates. After years of little or no change in rates, this pickup in the pace of activity should be a wake-up call for consumers.
Inflation driving higher bank rates
The Fed announced a 25 basis point increase in the target range for the Fed funds rate, which will now be from 0.75 to 1.00 percent. This follows on the heels of a 25 basis point rise in that target range announced after the Fed's December meeting.
What the Fed did may be less significant than the reason behind it. The Fed's announcement noted that inflation had increased in recent quarters. Inflation is a driving force behind all interest rates, not just those set by the Fed. If inflation continues to rise, expect it to force bank rates higher.
What bank rate hike means for mortgages, savings rates
While the Fed only directly controls very specific short-term interest rates used by banks, its actions and especially the reasons behind those actions will have a wider impact. Here are some examples:
1. Prospective home buyers should expect higher mortgage rates
While short-term interest rates only have an indirect impact on long-term mortgage rates, lenders are acutely aware of inflation trends. The same uptick in inflation that the Fed is responding to has already contributed to a rise in 30-year mortgage rates by about three-quarters of one percent over the past six months. More inflation should lead to further mortgage rate increases.
2. Refinancing rates may be affected
While would-be home buyers have to worry about rising borrowing costs, some current home owners will be affected as well. Those thinking of refinancing or taking out a home equity loan may find it is no longer financially viable if they wait much longer. Home sellers need to be concerned that rising rates might dampen buyer demand if the process drags out too long.
3. Savings account rates won't respond automatically
One might expect rising Fed rates to correspond with an increase in savings account rates and other bank rates for deposit accounts. However, that has not been the case with the past two Fed rate increases. This is especially troubling given the acceleration in inflation because it means that depositors who have already been falling behind rising prices will find themselves losing even more ground.
4. The value of shopping around for the best rates may increase
Both lenders and deposit institutions will respond to this more volatile rate environment in different ways, meaning the dispersion of rates offered by various institutions could increase. That means that shopping around for better rates can have an even greater payoff as these differences widen.
The next Fed rate announcement will occur May 3, but in the meantime consumers can get some clue about the future of interest rates by keeping an eye on inflation. If price increases continue to accelerate, it will make things even more challenging for consumers.