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Fed increases interest rates

By Ben Woolsey

Consumers will soon pay higher rates on their variable-rate credit cards and home equity lines of credit, after the Federal Reserve once again raised the nation's interest rates in an effort to combat inflation. According to a survey taken prior to the rate hike, on June 28 the average standard variable credit card APR was 14.29 percent.

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On June 29, the U.S. central bank boosted the federal funds rate by a quarter point to 5.25 percent. Therefore, the prime rate (which is always 3 percentage points higher than the federal funds rate) will increase to 8.25 percent. Some types of consumer debt, including variable-rate credit cards and equity lines of credit, move up and down with the prime rate. The Fed's actions have only an indirect impact on the rates of longer-term debt.

The Fed's decision to increase rates did not come as a surprise to economists. This latest interest rate hike is the 17th straight time the Fed has lifted interest rates by a quarter point since this cycle of rate hikes started back on June 30, 2004. For a year prior to that, the federal funds rate had remained at 1 percent and the prime rate at 4 percent.

With prices for goods and services rising a bit faster than the central bank wants, the Fed's challenge is to control inflation without hurting the growth of the economy. Higher interest rates work to cool an overheated economy by encouraging consumers and businesses to borrow and buy less. The resulting decrease in demand should moderate prices.

For many people who monitor Federal Reserve activity, what the Fed says is as important as what it does. Market watchers use the central bank's comments to predict what it will do in the future, which is important for future-looking stock market players. In its latest announcement, the Fed toned down its language regarding potential upcoming rate hikes, saying, "The extent and timing of any additional firming that may be needed to address risks will depend on the evolution of the outlook for inflation and economic growth." That marked a change from May, when it declared that "some additional firming may be necessary."

That change in language suggests that while the central bank may raise interest rates once again, there probably will not be many more rate hikes to come. Instead of warning that inflation represented a powerful threat, the Fed suggested that the job of slowing inflation may not be quite done.

Inflation has risen in the last six month, partially due to the surge in energy prices, but also as a result of higher housing prices. However, the economy seems to have slowed significantly from the red-hot growth experienced during the first six months of this year. On Thursday, the government released its final estimate for economic growth in the first quarter, which it revised upward to an annual pace of 5.6 percent from 5.3 percent in the previous report, putting expansion far above the pace that most economists feel is sustainable without rising inflation. Still, many forecasters now believe that growth has moderated to something around 3% in the second quarter and will remain near that level for the remainder of the year.

Cardholders should not panic about this latest increase. If you are consistent with paying your balance in full and on time each month, the higher prime rate will not impact you. Also, if you are among those consumers in an introductory period offering low interest or 0 percent APR, you are in the clear.

Published: June 1, 2006


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