The expected interest rate hike took place on 15th of March 2017. Let’s not forget that there are expectations for an additional increase in Federal Fund rate by the end of 2017. A total of three interest rates hikes is expected for this year. Increase in interest rate is showing stronger economy
The anticipation is that the increase in interest rate will eliminate or at least decrease the danger of inflation. The downside is that it will increase the cost for existing and new borrowers.
The key interest rate for overnight lending has been increased by 25 basis points. Namely, from the existing range of 0.5 percent – 0.75 percent to a new range of 0.75 percent to 1.0 percent. Going down the memory lane, Fed executed its first rate hike since the global financial crisis in December 2015, and the second rate hike took place in December 2016. Noteworthy mentioning is that in 2009 the interest rate had a range of 0 percent to 0.25 percent. Showing a nearly zero percent interest rate.
A brief overview of the three interest rate hikes since 2009:
First interest rate hike – December 2015 – with a new range of 0.25% to 0.5%
Second interest rate hike – December 2016 with a new range of 0.5% to 0.75%
Third interest rate hike – March 2017 with a new range of 0.75% to 1.0%.
It can be seen that the increase in interest rates amounts to 25 basis points for each interest rate hike.
Effects from interest rate hike
The interest rate increase has a widespread effect in the economy. Specific segments which will feel the effect are individual and households borrowers and savers.
The effects should not be discussed only in terms of how the rise affect borrowers, savers should also be taken into account. Namely, in a period of increases in the benchmark rate, there are always parties which will earn more or pay more. This is especially true for existing borrowers having signed a loan agreement with a flexible interest rate. Because of the opposite effect savers will hope for an increase in interest rates, will borrowers will welcome any decrease in interest rates.
It should also be noted that there is a tendency for the interest rate on loans to increase faster than the increase in deposit interest rates. It can be said that FED’s key short-term rate has an effect on the long-term rate as well but this effect is indirect.
Therefore, it is also expected that the interest rate hikes will result in gradual upward movement of mortgage interest rates. Borrowers with loans bearing adjustable interest rate will most likely be affected by the rate hike. Borrowers currently paying adjustable rate on their loans should not forget that the adjustment is usually performed on annual base. Thus, if there are a couple of interest rate hikes in the meantime, it could have a higher impact on mortgage payments.
Individuals with credit Card debt will be faced with a quarter of a percentage point increase in the cost of their credit card debt i.e. interest rate.
Savers will benefit from the current and expected increases in benchmark rate because they will earn more on their saving accounts
It is well known that when FED increases short-term interest rates, banks tend to pay higher interest rate on their deposits. But it is difficult to estimate by how much the interest rate on deposits will increase and when. The expectations for additional rate hikes may depend on how well the economy will perform in the upcoming period.
While increases in Federal fund rate is good news for savers, it will increase the cost of existing and new borrowers. Namely, customers with Certificates of Deposits are going to earn more interest income. On the other hand, borrowers will have to pay higher interest rate, thus their monthly payment will increase. That is if they are paying an adjustable interest rate on the loans.
So savers should just be patient and wait for the anticipated interest rate hikes to happen. Borrowers on the other hand, especially borrowers with a mortgage loan, can consider locking down the interest rate in case they opted for adjustable rate mortgage. New home buyers should decide whether or not to buy their home before any additional interest rate hike. This way they could have a lower cost on their mortgage.