Consumers could be looking at higher borrowing costs for many months to come.
- Borrowing costs have increased due to the Federal Reserve raising interest rates.
- The Fed does not plan to cut interest rates until inflation has cooled substantially.
On December 14, the Federal Reserve raised its benchmark interest rate by 0.5%. That’s a smaller increase in interest rates than what we’ve seen over the last four Fed meetings. But still, that’s pretty aggressive growth.
The news, however, did not sit well with investors. Many had hoped for a smaller rate hike in light of recent news that inflation appears to be cooling. In fact, stock prices plummeted following the announcement, causing many investors to lose their brokerage accounts.
But as disappointing as another rate hike might be, there’s more bad news. Federal Reserve Chairman Jerome Powell said that while the Fed may not have to raise additional interest rates in 2023, consumers shouldn’t expect rate cuts in the new year either. And that means the cost of borrowing is likely to remain high for the foreseeable future.
A lot of pressure on consumers
The Federal Reserve does not directly set consumer borrowing rates. Rather, it controls the federal funds rate, which is the rate that banks charge each other for short-term borrowing.
But when the Fed raises its benchmark interest rate, it tends to raise borrowing costs implicitly. That explains why everything from mortgage rates to auto loan rates to personal loan rates are so much more expensive these days than they used to be. In fact, mortgage rates are now more than double what they were at the end of 2021.
Unless the Fed cuts interest rates in 2023, consumers can expect the cost of borrowing to remain high. And that’s on purpose.
The Fed wants consumers to cut back on spending because that’s what’s needed to help bring inflation back to a more moderate level. But the Fed may have high expectations in that regard.
On December 14, Powell was quoted as saying: “Our focus right now is really on moving our policy stance to a more restrictive stance that will ensure inflation returns to the 2% target over time.” However, at the moment, the rate of inflation is nowhere near 2%. The latest Consumer Price Index showed an annual increase in inflation to 7.1%. And it was a marked improvement from October.
Since we are worlds away from 2% inflation, we may as well be in for many months of expensive borrowing rates before the Fed gets what it wants. And that’s something consumers should be aware of.
It can pay to delay borrowing
Consumers who need a loan to buy a car or renovate their home may not be able to wait. But those looking to borrow for purposes such as renovations may want to sit tight for a while. Signing any type of loan right now means getting stuck with an uncompetitive interest rate. And there’s no reason to land in that situation if you can avoid it.
On the plus side, the Fed’s recent rate hikes have led to higher interest rates on savings accounts and certificates of deposit. So while consumers may be paying more to borrow, they’re also being paid more to keep their money in the bank.
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