On Wednesday, June 7, the U.S Federal Reserve announced its decision to raise interest rates and begin a reduction in its holding of bonds and other securities. Now, the interest rate is up a quarter point from its current 0.91% to 1% to 1.25%. This rate hike marks the second rate hike in three months and it suggests that the Fed is confident in the prospects of the U.S. economy. The rate hike also suggests that the Fed strongly believes that the recent improvements in the labor market are sustainable.
Fed chair, Janet Yellen observes that “What I can tell you is that we anticipate reducing reserve balances and our overall balance sheet to levels appreciably below those seen in recent years but larger than before the financial crisis.” Now, the Fed expects U.S. economic growth to increase by 2.2% in 2017. This piece looks at the effect on the increase in Interest rates on the finances of the average Joe.
Here’s how the rate hike could affect your wallet
Many people tend to ignore the actions of the Federal Reserve on interest rates because the Fed fund rate doesn’t seem to have much influence on the “real” economy. However, nothing could be further from the truth – the impact of the Fed fund rate on the real economy can never be overemphasized.
To start with, the Fed fund rate has a direct influence on the prime rate that banks use as a benchmark for determining interest rates. The Fed fund rate has a direct influence on most types of revolving debts with adjustable rates such as home equity loans and credit cards. Hence, an increase in the fed fund rate often gets transmitted to borrowers in the form of higher interest on debts.
As soon as the Federal Reserve announced its decision to raised interest rates, the U.S. bank prime loan lending rate (the interest rate used as a base for nonmortgage loans) recorded a marked increase. Now, the prime loan rate has increased from 4% to 4.25% in 15 of the major U.S. banks such as Citibank, Wells Fargo, and JPMorgan Chase.
Here’s what the Fed thinks about inflation
Inflation is another salient economic force that has a huge influence on the finances of everyday people. Inflation silently erodes the value of money by reducing the purchasing power of the greenback. The Fed thinks that the cumulative effect of its economic moves could rein in inflation as the economic outlook continues to improve.
The Federal Reserve has reduced its forecast on inflationary trend – the now Fed expects inflation to be at 1.7% by the end of this year, down from the previous forecast of 1.9%. In addition, the Fed notes that its measure of underlying inflation has declined to 1.5% from the 1.8% reading at the end of the year. Underlying inflation has been below 2% target of the Federal Reserve for more than 5 years.
In addition, the Labor Department agrees with the Fed that the inflationary trend in the country is heading lower. The Labor Department noted that consumer prices recorded a significant drop in May to mark the second significant decline in the last three months. If the economy continues to strengthen in line with the expectations of the Fed, we can reasonably expect inflation to drop going forward.