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Fed again leaves interest rates at historic low

Analysts say key lending rate likely won't change anytime soon

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In an effort to preserve what analysts deem "a fragile recovery," the Federal Reserve has again left interest rates unchanged.

Federal Reserve monetary policy announcement

At the conclusion of a two-day meeting, the Fed voted unanimously to leave its federal funds rate at a range of 0 percent to 0.25 percent, keeping the prime rate at 3.25. Variable rate credit cards -- which account for the majority of plastic -- have annual percentage rates that are set using the prime rate.

"Although economic activity is likely to remain weak for a time, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability," the Fed said in a statement. "The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time."

The last change to the federal funds rate came in December 2008.

Experts say that the Fed is likely to keep rates at record low levels for some time. "Not only did the Fed keep rates unchanged today, I believe they'll keep rates unchanged for the next year," says Greg Valliere, chief policy strategist at Soleil Securities Corp. in New York City.

Those low rates could encourage credit cardholders and other borrowers. "Monetary authorities are going to keep their foot on the pedal and that is going to translate into reduced borrowing rates in the hopes of supporting demand as we move into a fragile recovery," says Joseph Lupton, senior economist with JP Morgan Chase.

Low rates to spur card use
With the economic recovery in mind, the Fed has a reason to maintain low rates. "Heading into the holiday season, they last thing they want to see is a move higher in market rates, which would translate into a move higher for mortgage rates and credit cards," Valliere says.

That's because the economic recovery depends heavily on consumers' willingness to spend money: The nation's gross domestic product is approximately 70 percent comprised of consumer expenditures. The latest report showed gross domestic product declined by a 1.0 percent annual rate in the second quarter, a slowdown in the pace of contraction from the 6.4 percent fall in the first quarter, which was the worst economic pullback in 27 years. However, the U.S. savings rate and declining credit card balances suggest that cardholders aren't in any hurry to begin running up their credit card bills once more. 

"This has been a really tough course for the retailers," says Elizabeth Rowe, director of banking advisory services with Mercator Advisory Group in Maynard, Mass., noting the way consumers have slowed their spending. "This change in behavior has played itself out in every mall in America," she says.

Fixed-rate credit cards disappearing

For Rowe, whether consumers personally experience the recession depends on their location, much as soldiers in a green zone can feel safe during war. "Once you go outside of the green zone, there is an enormous terrifying recession going on," Rowe says. "Where that green zone is is determined by where you live, what you do for a living" and other factors such income and education level. 

Banks make changes
Meanwhile, banks are shifting away from fixed rate credit cards and toward cards with variable rates tied to banks' prime rate -- which fluctuates based on the federal funds rate. That change could mean more and more cardholders are impacted by future Fed monetary policy decisions. While a variable-rate card, for example, would likely see its APR rise a quarter-point following a quarter-point increase in the federal funds rate, by definition, fixed-rate cards are unaffected by changes to prime.  

Although the Fed's key lending rate is at a record low now, it eventually will rise as the economic recovery gets under way. That increased number of variable rate cards could, therefore, in time serve to limit consumer spending, Lupton says. However, he adds that higher interest rates are only one factor that can change consumer demand for credit. "As people begin to believe we're out of the woods and the recovery will be sustained, that will provide a huge boost to demand for credit," Lupton says. 

According to Mercator's Rowe, banks are using the period ahead of when new credit card laws take effect to test out a variety of approaches. "[T]here's a little bit of chaos in the credit card marketplace," she says. Rowe says that the same issuer may use diametrically opposed lending techniques on different cardholders -- cutting credit lines for some borrowers while extending new offers to others. 

"Credit card issuers are treating this time as their own personal R&D [research and development] lab time because they are trying out their experiments now so they can be in more of a 'go mode' when the new regs take effect," Rowe says.

For now, though, the central bank's latest decision and accompanying language "is beneficial to all borrowers by trying to keep downward pressure on the rate structure," Lupton says. "That's accommodative for not just credit card borrowers, but auto loans, student loans, mortgages" and other types of borrowing, he says.  

See related: Variable interest rate cards replacing fixed rates , Consumer credit card balances plummet

Published: August 12, 2009


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