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Federal Reserve leaves interest rates at historic lows

Variable-rate credit cardholders can likely breathe easier for an 'extended period'

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Federal ReserveSmile, credit cardholders. A decision Tuesday by the Federal Reserve means that, barring a big mistake on your part, your credit card's interest rate won't be increasing anytime soon. 

In its first announcement since the landmark Credit CARD Act took effect in February, the central bank voted to leave the federal funds rate at a range of 0 percent to 0.25 percent, keeping the prime rate at 3.25 percent. Since the new law limits banks' ability to suddenly raise credit card interest rates, borrowers with variable rate cards -- which account for the majority of plastic -- shouldn't see their annual percentage rates (APRs) increase until the Fed boosts its key lending rate. Before then, only a big credit mistake, such as being 60 days late with a card payment, can trigger a change to your cards' current APR without the issuer first giving you 45 days' notice.

When the Fed finally does raise rates -- which last happened in July 2006 -- millions of U.S. cardholders will be impacted. That's because in recent months, many issuers have switched their cards from fixed rates to variable rates, which are tied to the prime rate. Since it's tied to the fed funds rate, the prime rate moves up and down as the central bank adjusts its key lending rate.  

"We do expect credit card interest rates to rise once the Fed begins to increase the funds rate," says Sean Maher, an associate economist with Moody's Economy.com. "The recent implementation of the CARD Act will restrain the increase in credit card rates, but once the Fed begins to tighten, interest rates will increase across the board, including credit cards." At its most recent peak in 2006, the prime rate was 8.25 percent, 5 percentage points higher than it stands now.

Searching for clues
When will rates begin rising? With no change in the Fed's stance on interest rates, analysts focused on what the central bank said and how its members voted. Those words and votes become a clue as to how monetary policy may unfold, since the Fed avoids explicit predictions about future rate decisions. For example, analysts remain focused on the central bank's statement that rates may remain "exceptionally low" for an "extended period," which one Fed president had said means rates won't rise for at least six months. 

It may take several meetings before the Federal Open Market Committee -- the Fed's monetary policmaking arm -- can come to an agreement. For the second straight meeting, the only dissenting vote came from Kansas City Fed President Thomas M. Hoenig. According to the Fed's statement, Hoenig said "that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to the buildup of financial imbalances and increase risks to longer-run macroeconomic and financial stability."

Although other FOMC members may soon join Hoenig's camp, analysts don't expect an increase just yet. "Given the significantly weak labor market conditions and soft demand conditions in the economy, the Fed is likely to wait until they see some meaningful improvement in employment before they take any action," likely during the early part of 2011, says Asha Bangalore, a vice president and economist at Northern Trust in Chicago. Other analysts say a rate hike could come before the end of this year.

Bangalore also says the Fed doesn't want to make borrowing even more challenging. "There is a serious credit crunch under way, and until they see the credit machine working again, they are unlikely to take action," she says.

Although too much lending can lead to an overheated economy, a lack of it can stifle the economy's growth. For the time being, economic weakness remains the Fed's main consideration: The unemployment rate remained at 9.7 percent in February, with nearly 20 percent of Americans still considered to be underemployed -- or working fewer hours than they'd like -- according to a Gallup poll taken in February. Trouble for consumers can translate into weaker spending and hinder the growth of the economy as a whole.

Accentuating the positive
Still, the Fed sounded an optimistic tone in the first sentence of the statement accompanying its decision. "Information received since the Federal Open Market Committee met in January suggests that economic activity has continued to strengthen and that the labor market is stabilizing," the Fed said.

Nevertheless, the Fed recognizes that the labor market is still an issue. "Household spending is expanding at a moderate rate but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit," the statement said.

With job woes likely to continue, the Fed said it continues to expect the health of the economy to require "exceptionally low levels of the federal funds rate for an extended period."

Analysts say the Fed's approach to monetary policy makes sense. "With few inflationary pressures and a still-fragile recovery, we think this is appropriate," Maher 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: March 16, 2010


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