Federal Reserve again leaves interest rates unchanged
Decision means no sudden APR hikes for responsible cardholders
By Jeremy M. Simon | Published: August 10, 2010
Amid signs that the economic recovery is in doubt, the Federal Reserve on Tuesday kept interest rates unchanged, leaving the majority of credit cardholders protected from sudden increases in their annual percentage rates.
At the conclusion of its Aug. 10 meeting, the Federal Reserve yet again left interest rates unchanged, voting to maintain the federal funds rate at a range of 0 percent to 0.25 percent. Their decision has the effect of keeping the prime rate at 3.25 percent.
That decision, when combined with the groundbreaking Credit CARD Act of 2009, means responsible credit cardholders shouldn't experience higher borrowing costs in the immediate future.
No change for cardholders
Although the latest Fed decision won't impact credit cards, the central bank's monetary policy does matter to cardholders. The reason? The bulk of plastic carries variable annual percentage rates (APRs), which can move up or down based on adjustments to the fed funds rate. That means when the Fed finally does raise the fed funds rate, the cost of credit card, auto and other loans will become more expensive. Before then, only borrowing mistakes by the cardholder, such as paying a bill more than 60 days late, can result in a sudden change in the card's APR.
Once the Fed increases its key lending rate -- which it last did in June 2006 -- millions of U.S. borrowers will pay more to revolve balances on their credit cards. That's because at present, the wide majority of existing cards -- and "99 percent" of all new credit card offers, according to research firm Synovate -- carry variable APRs tied to the prime rate. The prime rate moves up or down in lock step with the fed funds rate. Any change to the prime rate changes the variable APRs that are indexed to it.
Rate increases are typically used to stifle inflation when the economy heats up. For now, however, the Fed's primary concern is the slowing economic recovery and the danger that the U.S. could slip back into recession. Some FOMC members have even suggested the economy could enter a period of deflation. "Measures of underlying inflation have trended lower in recent quarters and, with substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time," the Fed statement said.
|PRIME RATE, FED FUNDS RATE
REMAIN AT ALL-TIME LOWS
The prime rate and the Federal Reserve's fed funds rate -- both of which are closely tied to credit card interest rates -- have been steady since Dec. 18, 2008. Prior to that, however, both rates saw huge drops as the nation dealt with the economic downturn.
The chart above shows just how far the rates have fallen since July 2007 -- just before the recession began. (NOTE: The prime rate is always 3 percentage points higher than the federal funds rate.)
Tough economic data
Analysts weren't suprised by the Fed's decision. Dennis Moroney, research director in the bank cards division with advisory services firm TowerGroup, pointed to a lousy batch of recent econonic data: June unemployment remained high, at 9.5 percent; the gross domestic product reading for the second quarter was weak and early reports from retailers suggest poor back-to-school sales. "If this wasn't bad enough, personal bankruptcies reported for July increased 9 percent from June. Year-to-date through June, personal bankruptcies were 14 percent higher than for the same period in 2009," Moroney says.
The Fed highlighted that economic weakness in the statement accompanying its decision. "Information received since the Federal Open Market Committee met in June indicates that the pace of recovery in output and employment has slowed in recent months."
The central bank's latest statement once again said lending rates may remain "exceptionally low" for an "extended period." Kansas City Fed President Thomas M. Hoenig was the sole dissenting voice for the fourth straight meeting, voting against the decision to leave interest rates unchanged.
But that doesn't mean the Fed was inactive. In an effort to keep money moving in the economy, the central bank said it will "keep constant" its security holdings by reinvesting the principal payments from agency debt and agency mortgage-backed securities. Essentially, when it gets repaid, the Fed is "going to go right back out there and buy U.S. Treasuries again," says George Mokrzan, senior economist with Huntington Bancorp. in Columbus, Ohio. The Fed's move should make banks more comfortable with lending overall. "It's at least a small positive toward consumer lending," Mokrzan says, even if this won't have a direct impact on credit card rates.
That means, for the time being, credit cardholders won't see a sudden rise in their APRs. Meanwhile, it will be business as usual for most lenders. "I expect that credit card issuers will continue to offer credit to the most credit worthy and those consumers with weak scores can expect low lines and interest rates above prevailing industry averages," Moroney says.
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