Fed holds interest rates near zero


After holding short-term interest rates near zero since the end of 2008, the U.S. central bank put off an increase still further on Wednesday, extending a reprieve for people who carry a balance on their credit card and other borrowers.

Since the FOMC met in September, "the pace of job gains slowed, and the unemployment rate held steady,"  the Federal Open Market Committee's official policy statement said.

To stimulate the economy, the committee voted to leave the federal funds rate, its lever on the banking system, at its current target range of 0 to 0.25 percent. The move delays the beginning of a potentially painful cost increase for people who carry debt -- including balances on variable rate credit cards.

But for how long? Most of the committee members are on record that the first rate hike -- termed "liftoff" -- should happen in 2015, according to the Fed's published projections. That leaves one more meeting, in December, before time runs out.The committee added a specific reference to the December meeting in its explanation of how it will decide future rate increases.

"The Fed has got itself into a bit of a pickle," TD Economics economists Beata Caranci and James Marple wrote in an analysis. The rate-setting committee has said its decision will depend on data, but the latest vital signs don't portray the strength that officials expected. As a result, Wall Street futures markets give only 30 percent odds of seeing liftoff before 2016 -- so a hike would rattle the investment world, and maybe your 401(k).

The alternative to raising rates this year will be a lot of explanations about shifting circumstances that forced a departure from the game plan. The Fed might damage its credibility by reneging on the rate hike, but experts don't dismiss the possibility.

"They won't say it, but they're always concerned about anything they do that could cause a serious adjustment in the stock indexes," said William Ford, a former FOMC member now teaching economics at Middle Tennessee State University. "It will be a surprise and a shock to the market if they come out now and say they're going to be increasing rates."

Costs to rise for borrowers

Consumers have money riding on the rate decision, whether they realize it or not. Most card APRs rise and fall with banks' prime rate, which is tied to the federal funds rate. Adjustable rate auto loans, home equity lines of credit and personal loans also move in step with the prime, which is currently 3.25 percent.

A quarter-point rate increase -- the Fed's traditional increment -- will translate into an extra $13 in a year in interest for the average consumer's card balance, based on Fed figures and credit report statistics. More important, the first increase marks the beginning of a period of rising rates, during which FOMC members expect the benchmark rate to go up by about 3 percentage points in the next few years.

While borrowers will pay more interest, savers should start getting better returns on their money as market rates rise. The average interest paid on savings accounts is just 0.06 percent, according to the Federal Deposit Insurance Corp. That near-zero return doesn't match the rate of inflation, by some measures.

"Right now, savers have a negative rate of interest," said Ford, a former President of the Federal Reserve Bank of Atlanta. In other words, price increases are outpacing the interest that savers earn. When you exclude food and plunging energy, prices rose 0.2 percent in September, according to the Labor Department.

Economic murk

But to the Fed, inflation is too low, not too high. While any inflation is unwelcome to savers, moderately rising prices are a sign of healthy activity and a tight labor market. Over the past year, the Consumer Price Index of all items -- the largest market basket of goods and services -- was essentially unchanged.

"Inflation has been the dog that didn't bark during this expansion," Mesirow Financial Chief Economist Diane Swonk wrote in a preview of the Fed meeting.

Prospects for ramping up the economy don't look great. Retail sales barely rose in September, and August's figure was revised downward, while the latest reading on consumer confidence is down. That's a problem because economists are looking to shoppers at home to offset a drop in sales abroad, as economies in Asia and Europe stumble. A Fed rate increase would only worsen that trend by making the dollar stronger relative to foreign currencies -- in other words, raising the prices for U.S. goods that foreign buyers pay.

"Trade and, to a much larger extent, inventories will be material drags on GDP (Gross Domestic Product) growth," Regions Bank Chief Economist Richard Moody said in a preview of the week's major economic news. The government will release third-quarter GDP figures Thursday, the broadest gauge of the economy's strength, which Moody predicts will show annualized growth of 1.6 percent. On Friday another important report, on personal income and consumer spending, will provide more insight about the economy's health.

While the easiest course is to postpone the economic pain of a rate hike and collect more data to justify it, waiting has a downside as well. Zero interest rates "could encourage excessive leverage and other forms of inappropriate risk-taking that might undermine financial stability," Fed Chair Janet Yellen said in a September speech. Moreover, the Fed might have to tighten faster than it would like if inflation heats up quickly.

As Caranci and Marple of TD Economics wrote, "the Fed's decision on when to raise rates must also consider the risks of leaving rates at zero."

See coverage of previous FOMC meeting: Fed puts off interest rate hike

See related: What an interest rate increase will cost cardholders

Published: October 28, 2015

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