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Federal Reserve leaves rates alone, but with a twist

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The Federal Reserve didn't change interest rates on Wednesday, but it did say, "Come on, baby, let's do the Twist."

Federal Reserve

After previously committing to leave rates at current record lows through mid-2013, the Federal Reserve stayed true to its word on Wednesday, maintaining its key lending rate at 0 percent to 0.25 percent. That means that credit card holders will be spared the sudden APR increase that would have come with a rate increase. The Fed's key lending rate -- known as the federal funds rate -- has remained at that low level since December 2008, as the central bank waits for signs that the U.S. economy is finally strong enough to stand on its own.

"The Committee continues to expect some pickup in the pace of recovery over coming quarters but anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate" of low inflation and high employment, the Fed said in its statement. "Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets."

But the Fed showed that it isn't without options. Instead of adjusting rates, the Fed chose to sell shorter-term securities and buy longer-duration securities -- an action labeled "Operation Twist." It's a revival of a Fed effort from 1961, when Chubby Checker's song "The Twist" and accompanying dance craze were at their height. The idea behind "Operation Twist II" is the same: to lower long-term interest rates and raise shorter-term interest rates, with the hopes that a further decline in long term rates will spur American consumers to take out more mortgages and American companies to invest more in their businesses. 

That's the theory. However, there's debate as to just how much impact the move will actually have on the economy as a whole. 

Here's what's apparently not up for debate, though: The move means little for consumer cardholders, at least in the short term. "I doubt this will have much of an impact on credit card rates as the changes are relatively small," says Joseph Lupton, senior economist with J.P. Morgan. 

"With the fed funds rate already effectively at zero, there is little room for further Fed action on this front. Given that we are not expecting Operation Twist to lower long-term treasury rates much, the passthrough to consumer credit rates will be even more minimal." Lupton says. 

No sudden card APR increase ahead
In choosing not to raise rates for now, the Fed decision means consumers don't need to worry about a sweeping increase in credit card interest rates. Almost all U.S. credit cards have variable rates tied to the prime rate. The prime rate moves in the same direction and amount as the federal funds rate, the Fed's benchmark lending rate. That means when the Fed adjusts the fed funds rate, most credit card APRs follow that move almost immediately.

For the time being, however, such a broad-based increase in card APRs is unlikely. 

Still, the prime rate isn't the only thing that can make individual cardholders' APRs rise. Based on rules outlined in the Credit CARD Act of 2009, there are a few exceptions -- including an increase in the prime rate -- that would permit banks to raise a consumer's interest rates within the first year of opening his or her new account. For example, if the borrower makes a mistake -- such as missing a payment due date by more than 60 days -- that slip-up can cause a faster APR increase.

After the first year, the rules loosen a bit. Banks can typically raise increase rates as they choose, as long as they give cardholders at least 45 days' notice. However, as noted previously, the banks don't have to give that notice if the borrower makes a big credit gaffe.

Non-Fed factors more important
Experts say that the condition of the U.S. economy will have more of an impact on credit card APRs than any Fed policy.

"The state of the labor market and its impact on household finances are still important factors affecting credit card rates," says Ann Owen, an economics professor at Hamilton College in Clinton, N.Y.

That means although rates won't suddenly go up across the board, they probably won't go down, either. "Credit card issuers are concerned about the ability of households to pay back their debt. When the risk of losses on credit card loans is high, they will not lower rates as much as they would if they were more confident that they would be paid back," Owen says. 

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

Published: September 21, 2011


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