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Fed pledges no interest rate hikes for at least 2 years

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Worried by all those headlines about higher credit card interest rates coming? If your rates do increase, it won't be because of the Fed -- for at least two years.

PRIME RATE, FED FUNDS RATE
TO STAY AT RECORD LOWS


The Fed said Tuesday that it will leaves rates at historic lows until at least mid-2013. The chart above shows just how far the rates have fallen since July 2007 -- just before the recession began. (NOTE: The prime rate, which most credit issuers use in setting credit card rates, is always 3 percentage points higher than the federal funds rate.)

In its monetary policy announcement on Tuesday, the Federal Reserve kept interest rates at record lows and said they'll stay there until mid-2013. Since December 2008, the Fed's key lending rate has remained at 0 percent to 0.25 percent as the U.S. central bank's monetary policymakers await clear signals that the economy is out of danger. But the data suggests they'll be waiting for some time: The debt crisis in Europe is worsening, domestic unemployment remains high and the U.S. recently had its credit rating lowered for the first time by rating agency Standard & Poor's.

Some analysts say that a Fed rate hike at this time would only serve to slow the economic recovery. "They don't want to raise rates and tap on the brakes," says Sam Bullard, senior economist with Wells Fargo Securities. 

Instead, the Fed plans to leave rates alone until conditions improve, which Fed officials expect won't happen anytime soon. "The Committee currently anticipates that economic conditions -- including low rates of resource utilization and a subdued outlook for inflation over the medium run -- are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013," the Fed said in the statement released after Tuesday's meeting.

However, the Fed does have other tools it will turn to, if necessary. "The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ these tools as appropriate," the statement said. 

Rates won't rise
The Fed's announcement should also prevent a widespread increase in credit card interest rates. That's because the vast majority of U.S. credit cards have variable rates tied to the prime rate. When the Fed adjusts its key lending rate -- known as the federal funds rate -- the prime rate typically follows those up or down movements. In other words, once the Fed hikes the fed funds rate, expect most credit card APRs to follow. But based on its latest announcement, the U.S. central bank isn't poised to declare its work done anytime soon or follow that up by raising rates.

That means credit card borrowers have caught a break. "Given that the U.S. economy is skating dangerously close (along with Western Europe) toward a double-dip recession, consumer interest rates will remain at ultra-low levels for the foreseeable future," Tony Plath, finance professor at the University of North Carolina at Charlotte, says in an email.

Other experts agree. "Banks will benefit from lower borrowing costs from the Fed, and hence higher spreads on their loans to consumers," says Greg Daco, senior economist with IHS Global Insight. "This should help their bottom line without requiring any increases in credit card rates."  

That doesn't mean cardholders are completely in the clear, however. 

Individual borrowers could still experience higher APRs. With a few exceptions -- including an increase in the prime rate -- interest rates cannot increase during the first year of new accounts. After that, banks remain free to increase rates as they see fit, but must usually warn cardholders at least 45 days in advance, based on rules established by the Credit CARD Act of 2009. And mistakes by individual borrowers -- such as missing a payment due date by more than 60 days -- can trigger a more sudden spike in that cardholder's APR.

Next Fed move
Although the Fed isn't planning to act for at least two years, not all the members of the Fed's policy setting committee were in agreement about its latest announcement. Three dissenting voices -- Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser -- disagreed with the change in language. The three "would have preferred to continue to describe economic conditions as likely to warrant exceptionally low levels for the federal funds rate for an extended period," the statement said.

Regardless of that dissent, the Fed members appear to agree about at least one thing.

"They are going to want to keep monetary policy accommodative for as long as they can in the current environment," says Wells Fargo's Bullard.

See related: A guide to the Credit CARD Act of 2009

Published: August 9, 2011



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