Fed Interest Rate Hike
Recently, the Federal Reserve raised the federal interest rate. This is important to know because it can affect how you spend, save, and borrow money. Let’s take a closer look at what the federal interest rate is, how it helps inflation, and how the federal (“Fed”) rate increase will impact you as a consumer.
What is the federal funds interest rate?
The Federal Reserve is the central bank in the U.S. Its main job is to provide a safe, reliable financial system. Commercial banks rely on the Federal Reserve to maintain their deposit accounts or reserve accounts.
When banks need to borrow money to replenish their reserves, they turn to other banks that have extra reserves to lend to them overnight. That’s where the federal interest rate comes in.
Set by the Federal Open Markets Committee (FOMC), the federal interest rate is the interest rate banks charge each other to lend Federal Reserve funds overnight. It features a range and can go up or down over time.
How is the Fed interest rate determined?
The FOMC meets eight times a year to set the Fed interest rate and manage the economy. The rate is based on the current state of inflation and unemployment. When the FOMC hopes to slow the economy and control inflation, they’ll increase the Fed interest rate. On the flipside, when their goal is to lower the cost of borrowing and stimulate the economy, they’ll decrease the Fed interest rate.
How much did the Fed raise interest rates?
In July 2022, the Federal Reserve increased the federal interest rate by 0.75% to a range of 2.25% to 2.5%. This is the most significant hike since 1994. According to financial analysts, the Fed will likely raise rates to between 3% and 4% by the end of the year.
Why does the Fed cause interest rate hikes?
The main purpose of increasing the federal interest rate is to help fight inflation and control higher prices. A higher interest rate raises the cost of borrowing and in turn, encourages people and businesses to borrow and spend less. This is designed to lower demand and slow the rising prices.
How does the Fed rate hike help inflation?
The Fed interest rate hike helps inflation in a few different ways. One is by increasing the cost of borrowing money, which encourages people to save rather than spend. This reduces the amount of money in circulation and can help to control inflation.
Another way the Fed interest rate hike helps inflation is by making it more expensive for businesses to borrow money for investment. This encourages businesses to invest in more productive activities that will ultimately lead to higher wages and prices, helping to control inflation.
Finally, the Fed interest rate hike can help reduce demand for imported goods by making them more expensive relative to domestic goods. This can help reduce inflation by reducing the amount of money flowing into the economy from other countries.
How the Fed rate hike may impact you
Here are several ways the higher federal interest rate can affect your finances:
Credit card rates
Many credit card APRs are based on the prime rate, which is tied to the federal interest rate. When the federal interest rate and prime rate go up, credit card interest rates do too, making credit card borrowing more expensive. If you pay your balance on time and in full each month and avoid interest, however, you won’t be impacted.
Mortgage and loan rates
An increase in the federal interest rate makes it more expensive for lenders to borrow money to lend. As a result, they charge higher interest rates on mortgages and other loans, such as personal loans and car loans.
If the Federal Reserve raises its rate, some consumer banks will follow them and increase their rates on products like high-yield savings accounts and CDs. That’s why it can be in your best interest to check the interest rate on your savings account and shop around for a better option that lets you earn more interest and grow your savings at a faster rate.
A higher federal interest rate can impact you as an investor. If you invest in bonds and ETFs, for example, you may enjoy greater yields. When it comes to stocks, however, a higher rate can negatively affect stock prices and your earnings.
How to prepare for Fed rate hikes
If you’d like to prepare for interest rate increases by the Federal Reserve, follow these tips:
Review your personal finances
Take a close look at your bank statements, credit card statements, and investment statements. By doing so, you’ll understand how you’re doing financially and what you can do to improve your situation when Fed rate hikes happen.
Increase your savings
If possible, look for ways to boost your savings. This may require you to cut or reduce your expenses or increase your income. You might need to get rid of the gym membership you never use, for example, or pick up a part-time job or side hustle.
Eliminate bad debt
To prepare for Fed rate hikes, now is the time to focus on paying off your bad debt. Strategies like the debt snowball and debt avalanche methods can help you get rid of debt from car loans, student loans, and personal loans.
Improve your credit score
Make an effort to increase your credit score. Pay your bills on time, repay debt, and only apply for new credit when you absolutely need it.
Be prepared for future Fed rate hikes
Since the federal interest rate is expected to increase yet again, it’s important to prepare yourself. By taking control of your finances and understanding how rate hikes may impact them, you can mitigate the negative effects and take advantage of the positive effects of Fed rate hikes.