The higher the inflation rate, the more interest rates are likely to rise. Why FED increased its key interest rate to help fight inflation and get price growth under control?
In brief: Higher interest rates temper inflation by making it more expensive to borrow money, discouraging both consumption and business expansions. That weighs on wage growth and can even push unemployment higher.
When the interest rate is high, the supply for money is less, and hence inflation decreases, which means supply is decreased. In contrast, when the interest rate is decreased or low, the supply of money will be more, and as a result, inflation increases, which means that demand is increased.
The larger goal of the Fed raising interest rates is to slow economic activity, but not by too much. When rates increase, meaning it becomes more expensive to borrow money, consumers react by refraining from making large purchases and pulling back their spending. The idea is that in today’s high inflationary environment, this decrease in consumer demand can help bring prices back down to “normal.”
We’ve seen this scenario already play out a bit in the housing market. In the last six months, average 30-year fixed mortgage rates have gone from 3.22% on Jan. 6 up to 6.28% on June 14. This rate increase has caused a notable slowdown in mortgage demand, hitting a 22-year low in mortgage applications last week. And with consumers facing higher mortgage rates to pay for a house, home prices are starting to soften. Nearly one in five sellers have dropped their home price during the four-week period ending May 22, according to Redfin.
How you can benefit
For everyday consumers, this housing market could offer some good news. Laurence Kotlikoff, an economics professor at Boston University, tells that mortgage rates are still at historic lows (for now). In fact, a low fixed-rate mortgage may serve as a good hedge against inflation.
Not looking to buy a home? Consumers can still benefit from the expectation of more rate hikes in the coming months by refinancing any high, variable-interest debt that is likely to become even more expensive. While the Fed just recently announced a rate hike, it takes some time to “bake” into the market, so you should refinance any high-interest debt now before rates get even higher. For example, private student loan borrowers paying a high variable interest rate may want to refinance to a fixed rate to lock in what will ideally be a lower rate today than in the future. SoFi offers fixed-rate loans with loan terms of five, seven, 10, 15 and 20 years, plus no origination fees to refinance.
It may also be a good time to start investing in a tax-advantaged 401(k) or Roth IRA retirement account because of the stock market pullback — putting many stocks at a discounted price. Tara Falcone, CFP and founder of investing app Reason, agrees, telling Select that it’s a good idea to “take advantage of low entry points into certain stocks or other investments as the market adjusts to higher interest rates.”
By raising interest rates, the Fed is signaling there are economic factors that aren’t on course with their objectives. Fed Chair Jerome Powell has stated numerous times the goal is to bring inflation down to 2%, now from the current 8.6%.
Yet the con of raising interest rates is running the risk of sending the economy into a recession; it’s a delicate dance. Experts from the World Economic Forum predict there’s a strong chance for a recession in the next couple of years largely based on two factors: increases in unemployment and continuous high inflation. Bloomberg Economics models show the odds of a downturn by the start of 2024 at 72%.
