The Federal Reserve just raised the federal funds rate for the 10th consecutive time since March 2022, raising rates by 0.25%. This increase pushes the federal funds rate range to 5.00%-5.25%, the highest level since June 2006, according to a Fed press release.
With inflation slowing and employment stabilizing, some experts expected the Fed to hold off on raising interest rates this month. However, with another bank failure in the news – the recent collapse of the First Republic – and inflation still not at the 2% target, the Fed’s decision to gradually raise interest rates is not surprising.
In a press release on Wednesday, the committee made it clear that it is “very concerned about inflation risks” and that it hopes to “maximize employment” but that it will continue to make the necessary changes to monetary policy in order to reach the 2% inflation target.
Since early 2022, the Federal Reserve has been working to cool price hikes and tame runaway inflation. From groceries to gas, inflation has pushed up the costs of daily necessities. In response, the Fed aggressively hiked interest rates, its best tactic to try to bring down high rates. As the Fed raises interest rates, the cost of borrowing for loans, credit cards, and mortgages has also increased, making financing less expensive. However, it also increased interest rates on savings, certificates of deposit, and money market accounts.
With a Fed rate hike once again under our belt, you may be wondering what’s next. Is this the last Fed rate hike? Will interest rates continue to rise? Below, we’ll cover what to expect and what the latest price increase means for your money.
What is going on with inflation?
The inflation rate is now 5% for all items, year over year, according to the Bureau of Labor Statistics. That’s a stark difference from last year, when inflation reached record highs in June with an annual increase of 9.1%. Most categories fell from February to March, with exceptions in some categories, such as food away from home and housing. But even though inflation has slowed, prices remain high across the board.
However, even though the first quarter of the year was strong for the economy with low unemployment, the Fed is tasked with keeping the inflation rate low, ideally around 2%. Although previous Fed rate increases have helped reduce inflation, rates remain elevated, indicating that there is more work to be done.
During periods of high inflation, the dollar has less purchasing power, making everything you buy more expensive – even though you may not get more money. Despite positive signs from last month’s BLS employment report — hourly nonfarm workers saw a 0.03% wage increase, for example — many Americans live paycheck to paycheck, and wages are not keeping up with inflation rates.
What does a higher interest rate mean for the economy?
Small increases in interest rates indicate lower inflation, but that does not mean that high rates will fall overnight. Experts expect 2023 to be another challenging year as prices remain high and interest rates push up the cost of borrowing.
“Even with the goal of returning the consumer price index (CPI) to 2%, the large price increases in 2022 and early 2023 are now showing their wrath,” said Shannon Gray, certified financial planner and founder of InvestmentEdge Planning. Last year, Powell said the economy was going to feel some pain with future interest rate hikes, and we’re seeing some of the effects with recent bank failures, Gray adds.
“We’re clearly not out of the woods,” said Gray.
Still, many experts worry that further increases in the cost of borrowing money could cause the economy to contract too much, sending us into a recession: an economy that is shrinking rather than growing. The Federal Reserve acknowledges the negative effects and potential risks of this restrictive monetary policy. And at this point, a recession seems inevitable.
“I see a 70% chance of a recession right now,” Derek Delaney, a certified financial planner and founder of Farmed Financial Planning, said in March. If unemployment rises and employment is no longer stable, a recession could come sooner – but what happens next with inflation will play a major role in the likelihood and size of a recession.
“Time will tell if it’s a little trickier or a bit steeper,” said Kimberly Howard, a certified financial planner and founder of KJH Financial Services. If prices continue to rise, consumer spending is expected to slow.
What does this mean for your money
The recent Federal Reserve rate hike means that borrowers will continue to see higher interest rates on mortgages, credit cards, and personal loans. On the flip side, as interest rates continue to rise, you can benefit from increased earnings on your savings. But it’s worth noting that with inflation still high and wages not outpacing inflation, you can’t “beat” inflation—but you can get a better return on your savings in the meantime.
If you have debt or are concerned about future economic instability, here are some steps you can take now to prepare.
Build an emergency savings fund
APRs for savings accounts have increased significantly this year, topping out at 5.00% APY. But the savings and CD rates will soon plateau. While some banks may raise rates slightly in the coming days, in light of the Fed’s latest rate hike, experts don’t expect rates to rise much. So if you’ve been waiting for a long-term CD lock, now is the time to act. But that doesn’t mean you have to move all of your money out of a savings account.
Even if prices start to drop, it’s still important to build up your emergency fund. In the meantime, you can earn a good return on your money, but even after rates drop, we recommend keeping emergency savings somewhere easy to access, like a high-yield savings account, for easy access to your money. Over time, you may not earn the best rate if banks don’t raise APY as aggressively as last year. But you’ll have access to the money when you need it, and you can continue to make regular contributions.
The amount you need in your emergency fund varies, but many experts recommend between three and 12 months’ worth of expenses. Start saving what you can now – money can come in handy if you’re struggling with a job loss or unexpected costs as the economic downturn continues.
Dealing with new and outstanding debts
Raising interest rates for the tenth time, even just a little bit, means banks will follow suit, too, making it more expensive to finance a car or buy a home. Higher rates also make it more expensive to refinance your mortgage or student loans. On top of that, Fed increases will also raise interest rates on credit cards, so if you have a balance, it becomes more expensive to pay off your debt.
Before taking out a new loan or mortgage, make sure you understand exactly what you’ll owe: repayment schedule, potential fees, and interest rate. For any outstanding debts, create a debt repayment plan to shrink balances as quickly as possible.
“Look at the numbers and make informed decisions,” said Bobbi Rebell, certified financial planner and author of Launching Financial Grownups. “So is connecting with your family, because very few of us work in one economy.” Now is the time to consider paying off outstanding debt at a lower or fixed rate of interest, if that is possible, she said. You can also consider a balance transfer card — as long as you have a plan to pay the balance off before interest is due — or a debt consolidation loan.
Make sure to check if you have a fixed or variable interest rate. Many personal loans and mortgage loans have fixed interest rates, so if you borrowed recently, you may have a high interest rate that will last for the life of the loan. On the other hand, most credit cards have a variable interest rate – which means that the already high APR (averaging over 20% at the moment) on any balances will only grow as rates go up.
And even if we see the last rate hike by the Fed for some time, the cost of borrowing won’t come down overnight. “If the Fed slows or stops raising interest rates, it doesn’t necessarily mean your rate will go down. It might just mean it won’t go up,” Rippel said. Don’t wait to take action. If you need to move debt into a fixed rate loan, you better move now in case rates increase further in the coming months.