Federal Reserve Chairman Jerome Powell last week solidified expectations for a half-percentage point rate hike at the central bank’s May meeting as officials look to tame red-hot inflation, a move that could have major implications for millions of US households.
Central bank policymakers raised rates by a quarter-percentage point in March, but have since confirmed that sharper, half-point increases are likely in the coming months, beginning in May, as they look to tame sky-high inflation. The government reported earlier this month that prices soared by 8.5% in March from the previous year, the fastest pace since 1981.
“It is appropriate to be moving a little more quickly,” Fed Chairman Jerome Powell said last week during a panel discussion at the International Monetary Fund and World Bank spring meetings. “I also think there’s something in the idea of front end-loading whatever accommodation one thinks is appropriate. So that points in the direction of 50-basis points being on the table.”
Traders are already pricing in a 100% chance of a half-point rate increase during the Fed’s May meeting, in addition to at least three more 50-basis point hikes at the US central bank’s subsequent meetings in June, July and September, according to the CME Group, which tracks trading.
By September, traders expect the federal funds target range to be at least 2.25% to 2.5%, well above the current range of 0.25% to 0.50%.
Hiking interest rates tends to create higher rates on consumer and business loans, which slows the economy by forcing employers to cut back on spending. For most borrowers, the higher interbank lending rate – which affects borrowing costs, including things like auto loans and credit cards – is bad news. Even a slightly higher rate for both can mean thousands of dollars in savings for consumers.
Mortgage rates have already climbed above 5% for the first time since 2011, with the 30-year fixed-rate mortgage – the most popular home loan product – hitting the threshold just five weeks after it topped 4%. It marked the fastest pace of increases since 1994.
“We’re going into some challenging times and there is a lot of sentiment out there that we could even be heading towards some sort of recession,” said Frank Sorrentino, chairman and CEO of ConnectOne Bank. “Nobody knows for sure, but we can expect changes from the current environment we’ve seen over the past two years, and the concept of cheap, easy money with no credit issues will change.”
The correlation between Fed rate hikes and borrowing costs isn’t quite so direct, however: The Fed raises the cost of borrowing for banks, which in turn passes that along to consumers. Congress tasked the central bank in 1977 with promoting “maximum employment, production and purchasing power” by keeping the cost of goods stable and creating solid labor-market conditions.
Typically, when policymakers are trying to spur additional consumer spending, they lower interest rates to reduce the cost of borrowing (in March 2020, for instance, the Fed slashed rates to near-zero in order to prop up the economy throughout the COVID-19 pandemic). Conversely, to combat inflation and cool the economythe Fed will raise rates to make borrowing more expensive.
Although the federal funds rate is not what consumers pay directly, most banks and credit unions will raise their savings rate during periods of higher interest rates, making it a good chance for consumers – particularly retirees living off of their savings – to earn more.