In late July 2018, the Federal Reserve stated that there is strong economic growth, which means it will continue to increase interest rates to head off inflation. The current Federal Funds Target rate is in the range of. 2%. The Fed believes the US economy is rising at a good rate and household spending is on the increase.
Federal Open Market Committee members also indicated during their last meeting in summer 2018 that inflation readings will be around 2% by the end of this year, and total annual GDP growth for 2018 will be almost 3%.
This good economic news means the US economy is quite stable and should help to reduce the odds of recession in the near term.
Because of economic conditions, it does seem likely that the Trump administration and Federal Reserve will continue to increase rates. Here are the top reasons why:
- Economic growth for Q2 2018 was over 4%. This is the first time economic growth has been this high since 2014. With strong economic growth above 4%, it is possible that inflation will occur at a higher rate. To head this off, the Trump administration and Federal Reserve increase interest rates to make it more expensive to borrower money.
- Unemployment is below 4%. This indicates the job market is healthy and there is plenty of work available. When people have more work and more money, they spend more. If interest rates are too low, it can make borrowing money inexpensive and this can lead to inflation in a strong economy.
- The housing market is strong. Housing market growth for the last year was approximately 6%. This is the strongest growth in housing prices in more than five years. Again, this suggests the US economy is on strong footing as is the US housing market.
- Wages are on the rise. As people are earning more money, this will cause they to spend more, which can cause an increase in inflation.
- Consumer confidence index is high and rising. As people feel more confident in their economic picture, they are more likely to spend money, which can again increase inflation and damage economic growth.
What Happens When the Federal Reserve Increases Interest Rates
The purpose of increasing interest rates is to raise the cost of borrowing money to prevent the US economy from overheating and hurting economic growth. When the economy gets too hot, inflation rises. This causes prices to go up and reduced prosperity.
When the Fed raises rates, it has an effect on several things, including:
- The Prime Rate: An increase in the Feds rate causes the Prime Rate to go up, which is the rate of credit that banks give to customers that are most worthy of credit. This is the rate that most types of consumer credit are based upon. Higher prime rates mean that banks will increase the costs of most types of borrowing.
- Credit card rates: Rates for credit cards and other personal loans will increase when the prime rate is increased.
- Savings: Money market and certificates of deposit will go up when the prime rate goes up. This can boost savings of consumers and businesses, so they can generate more returns on savings. But it is possible that anyone with debt may choose to pay it off as rates continue to rise.
- National debt: The increase in interest rates will boost what it costs for the US government to borrow money. It is estimated that the US government could pay nearly $3 trillion over the next 10 years because of interest.
However, there are some things that are not always affected right away when the Fed increases rates. For example, auto loans do not always increase quickly because these are longer term loans. Also, mortgage rates tend to be more affected by the 10-year Treasury note yield. This is largely not affected by rates of inflation.
Generally, we expect the Trump administration and the Federal Reserve to continue to increase interest rates to reduce the chance of inflation as the US economy improves. While higher rates are in some ways bad news for consumers, they generally indicate a stronger economy, which has its own benefits for millions of Americans.