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Nervous Fed continues to hold interest rates steady

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Federal Reserve continues to hold interest rates steadyA fretful Federal Reserve left interest rates unchanged once again Wednesday, meaning the bulk of credit cardholders can rest assured that their credit cards' APRs won't be going up anytime soon.

At the conclusion of its two-day meeting on June 23, the Federal Reserve once more decided to leave interest rates unchanged, voting to keep the federal funds rate at a range of 0 percent to 0.25 percent and leaving the prime rate at 3.25 percent. When combined with the groundbreaking Credit CARD Act enacted in 2009, that Fed decision means responsible credit cardholders are unlikely to see a rise in borrowing costs in the immediate future.

The decision is important because most credit cards have variable annual percentage rates (APRs), which can move up or down depending on changes to the fed funds rate. So when the Fed finally does push the fed funds rate higher, the cost of credit card, auto and other loans will go higher. Ahead of a Fed rate hike, only serious slip-ups by the cardholder, such as making a payment 60 days late, can lead to a sudden change in cards' current APR.

According to some experts, the Fed -- which last raised lending rates in June 2006 -- won't raise them again before next year. Once the Fed takes that step, millions of U.S. cardholders will experience higher costs when carrying a balance on their plastic. That's because the vast majority of current credit cards -- and "99 percent" of all new credit card offers, according to research firm Synovate -- have variable rates tied to the prime rate. The prime rate is based on the fed funds rate and moves up and down in conjunction with changes to the Fed's key lending rate. Any change in prime is followed immediately by changes to variable APRs. 

The Fed statement indicated it was concerned that the economic recovery was in danger of faltering. "Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad," the Fed said.

Studying the Fed's statement
Until then, responsible cardholders should see their rates hold steady -- possibly for quite some time. Analysts say that FOMC policy won't be adjusted before next year. Moody's Economy.com, for example, says that the central bank will wait until the first half of 2011, at the earliest, before tightening its monetary policy. "The Fed will keep interest rates at rock bottom until its comfortable that recovery has transitioned into a self-sustaining expansion and the unemployment rate has moved definitively lower," says Ryan Sweet, senior economist with Moody's Economy.com.

FED FUNDS RATE, PRIME RATE
STAYING AT HISTORIC LOWS

The federal funds rate and the prime rate, both of which are closely tied to credit card rates, have been unchanged since Dec. 18, 2008. The months prior to that, however, featured a huge drop in both rates as the nation wrestled with a powerful economic recession.
The chart above shows how far the two 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.)

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.

Job woes continue
Just a few months ago, many economists were predicting a Fed rate hike as soon as the end of this year. Not any more. Those upbeat predictions have undergone some adjustment as data continues to show that the U.S. economy is struggling to recover, including an unemployment rate that remains near 10 percent.

Once signs suggest that the economy has regained sufficient strength, only then will the Fed begin to raise rates. At first, that shouldn't prove problematic for consumers, experts say. As the fed funds rate comes off historic lows, Sweet of Moody's Economy.com says those first few rate increases won't have a significant impact on borrowers. "With the labor market improving and wages edging higher, consumers should be able to take a few Fed rate hikes in stride," Sweet says. 

But once the cycle of rate hikes begins to pick up, credit cardholders who carry a balance will begin to feel the pinch, says Anuj Shahani, director of competitive tracking services for Synovate's financial services group. Shahani says that as the prime rate increases, cardholders can expect higher minimum card payments and additional years before they are able to pay off their balances.

Other experts agree that cardholders' expenses will rise. "As the central bank becomes more aggressive in raising rates in 2012, consumers will begin to feel the effect of higher borrowing costs," Sweet says.

See related: Credit card reform law arrives, A comprehensive guide to the Credit CARD Act of 2009, Variable interest rate cards replacing fixed rates

Published: June 23, 2010


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