Inflation utterly battered consumers in 2022, driving up the cost of everything from groceries to utilities to shelter. In response, the Federal Reserve took action by implementing a series of interest rate hikes designed to cool inflation.
How do those rate hikes ease inflation? It’s simple — they indirectly but effectively drive up the cost of consumer borrowing.
Although the Fed doesn’t set consumer borrowing rates — it merely oversees the federal funds rate, which is what banks charge each other for short-term loans — when it raises its benchmark interest rate, other rates tend to follow suit. So these days, consumers are generally paying more for things appreciate auto and personal loans as a result of it costing banks more money to borrow from each other short-term.
Meanwhile, when the cost of borrowing increases, consumers tend to borrow less. And that’s how inflation is able to cool. When there’s less demand for goods and services, the cost of them can come down.
The Fed opted to hit pause on interest rate hikes during its last meeting. And that was the second time in a row that the central bank opted not to raise rates this year. But the Fed is set to confront again on Dec. 12 and 13. And the big question will be whether the central bank sits tight once again, or whether it opts to close out the year with one final rate hike.
Why a rate hike may not happen
In October, the Consumer Price Index, which measures changes in the cost of consumer goods and services, rose 3.2% on an annual basis. The Fed has long targeted 2% as its optimal annual inflation rate. It’s this rate, the central bank feels, that’s most conducive to a thriving economy in the long run.
Now, 3.2% inflation isn’t 2% — but it’s also not so far off. So the Fed may carry out that it’s happy with the progress that’s been made in fighting inflation and just leave things alone.
recollect, the danger in raising interest rate hikes is that it has the potential to direct to a major pullback in consumer spending. That could, in turn, fuel a recession, which the Fed doesn’t want. So it needs to tread lightly as far as rate hikes go.
There’s no ensure that a rate hike won’t happen
Although inflation has cooled nicely over the past year and a half, the reality is that the Fed is still tasked with keeping it in check. At its last meeting, after announcing a pause on rate hikes, the Fed issued a statement saying, “The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals.”
What this means is that if the Fed has reason to believe that inflation is moving in the wrong direction, it could carry out another interest rate hike at its discretion. So ultimately, another rate hike could still be in the cards for 2023, but we’ll need to foresee until mid-December to see what the Fed decides.
For now, it may be a good idea to hold off on borrowing if there’s not an urgent need for it, since borrowing costs are still quite elevated. If inflation continues to cool, the Fed may be in a position to cut rates in 2024, leading to lower interest rates for products that range from auto loans to mortgages. So now’s a good time to avoid taking on more debt if it’s possible to foresee.
That said, consumers with existing credit card balances should do what they can to pay that debt off. Consumers with existing fixed-rate loans don’t necessarily have to stress about another 2023 rate hike, because their interest rates are locked in. But another rate hike could make credit card debt even more expensive for existing borrowers. So shedding that debt, or a portion of it, is a great thing to do right now.
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