After nearly a decade of low-interest rates, the Federal Reserve has started increasing the federal funds rates (the interest rate that it charges banks) and the banks are also raising rates they charge to consumers (the consumer). While it brings higher costs for borrowers, it going to help savers with higher returns. Consumer discretionary spending traditionally moves in the same direction with interest rates in the short-term due to more people working and increased incomes which inevitably lead to increased spending.
- The CPI report indicates that a rate hike is still likely. New Labor Department data out this past Friday shows that workers’ wages in the U.S. continue to rise.
- With a low unemployment rate, an inflation rate drifting toward the Federal Reserve’s target, and increased spending, current interest rates don’t adequately match the strength of the economy, which is considered to be very strong.
- However, consumer spending will continue to increase since most consumers will not see a measurable change in purchasing power.
As of September 13, 2018, the benchmark 30-year fixed mortgage rate jumped seven basis points to 4.78 percent from 4.71 percent last week, according to Bankrate.com’s weekly survey of the nation’s largest mortgage lenders. The average rate for 15-year fixed mortgages also climbed five basis points to 4.21 percent, while the average rate for adjustable-rate mortgages, or ARMs, shot up six basis points to 4.20 percent.
Meanwhile, mortgage demand continues to cool as rates climb. Total mortgage applications dipped 1.8 percent from one week earlier, according to data from the Mortgage Bankers Association’s weekly survey ending Sept. 7.
Inflation is the rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of currency is falling. Inflation and interest rates are often mentioned in the same breath, and this is because inflation and interest rates are closely related. In the United States, baseline interest rates are set by the central bank, the Federal Reserve Bank also known as the Fed. Basically, here is how the Fed reacts and controls interest rates:
- In order to control high inflation, the central bank increases the interest rate.
When interest rate rises, cost of borrowing rises. This makes borrowing expensive.
Hence borrowing will decline and as such the money supply (i.e the amount of money in circulation) will fall. A fall in the money supply will lead to people having lesser money to spend on goods and services. Hence, they will buy a lesser amount of goods and services. This, in turn, will lead to a fall in the demand for goods and services. With the supply remaining constant and the demand for goods and services declining; the price of goods and services will fall.
- In low inflationary situations; the interest rate is reduced. A fall in interest rates will make borrowing cheaper. Hence, borrowing will increase and the money supply will also increase. With a rise in money supply, people will have more money to spend on goods and services. So; the demand for goods and services will increase and with supply remaining constant this leads to a rise in the price level (i.e inflation).
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