Prime Interest Rates

The central bank’s Federal Open Market Committee left the target for the federal funds rate at 2 percent, as expected. The prime rate will remain 5 percent. Most home equity lines of credit and variable-rate credit cards are based on the prime rate, and their rates will not change.

The rate-setting committee meets eight times a year. In the previous seven meetings dating back to last summer, the panel cut rates. The reduction in the federal funds rate was unusually rapid, going from 5.25 percent in September to 2 percent in April, as the Fed fought off a credit crunch.

With the economy in a slump, and with prices rising rapidly, the Fed has found itself in a dilemma. Short-term rates already are low, and if the central bank cuts them more to stimulate economic growth, then prices could rise even faster and get out of control. If the Fed raises short-term rates, the result could be a recession (or a deeper recession, if the economy already is in one) and a delayed recovery.

With inflation moving higher on its worry list, the Federal Reserve held interest rates steady Wednesday, ending nearly a year of cuts to bolster the economy, and hinted that the next direction for rates could be up.

Fed Chairman Ben Bernanke and all but one of his central bank colleagues agreed that the best course was to leave a key rate alone at 2 percent, as the country slogs through the crosscurrents of plodding economic growth and zooming energy and food prices that threaten to spread inflation.

That meant the prime lending rate for millions of consumers and businesses stayed at 5 percent. The prime rate applies to certain credit cards, home equity lines of credit and other loans.

The decision brought to a close a powerful series of rate reductions that started in September and extended through late April. It was the central bank’s most aggressive intervention in two decades to shore up an economy bruised by the trio of housing, credit and financial crises.

On Wall Street, stocks ended with a modest gain. The Dow Jones industrial average closed up 4.40 points to 11,811.83. Broader stock indicators managed to log stronger gains than the blue chips.

The Fed said it believes its rate cuts will “promote moderate growth over time” as they work their way through the economy. It also said risks that economic growth will falter appear to have “diminished somewhat.”

Short-term interest rates will come down again, for the seventh time since September.

The Federal Reserve cut its target for the federal funds rate by a quarter-point, from 2.25 percent to 2 percent. The prime rate will fall by a quarter-point, from 5.25 percent to 5 percent. The move spells good news to people who borrow money on loans, such as home equity lines of credit, that are linked to the prime rate. It’s not such good news for savers who want to put their money in short-term certificates of deposit.

The rate-setting Federal Open Market Committee has been slashing rates to encourage consumers to borrow, and therefore stimulate the faltering economy. At the beginning of September, the federal funds rate stood at 5.25 percent; since then, the Fed has cut it by 3.25 percentage points. It has been an unusually rapid series of rate reductions, as the Fed has tried to catch up with the economic slowdown brought on by the housing slump.

“Recent information indicates that economic activity remains weak. Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation have risen in recent months. The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to moderate growth over time and mitigate risks to economic activity,” according to the Fed announcement.

The Federal Reserve knocked 25 basis points off a key interest rate.

This rate cut had been expected, with futures markets pricing in a 1-in-5 chance that the Fed would keep rates unchanged, and a 4-in-5 chance of a quarter-point cut. To the extent that anyone expected the Fed to keep rates unchanged, that sentiment stemmed from the inflation picture. As anyone who drives to the grocery store knows, prices for gasoline and food have been skyrocketing and threatening to eventually push up prices for everything.

Typically, rate cuts make inflation worse. That makes the case for holding short-term rates steady. But this isn’t a typical situation. Prices aren’t rising because the economy is booming; instead, they are rising despite an economic downturn.

“It’s a compromise between two equally persuasive arguments,” says Richard DeKaser, chief economist for National City Corp. “On the one hand, there’s an increasingly legitimate argument that inflation needs to be pre-empted more aggressively.” On the other hand, he says, “there is still risk to the economy in terms of weaker growth.”

Bernanke sends clear message: Bernanke made two speeches earlier this week, but his remarks Tuesday validated the widely held belief that the Fed intends to move to the sidelines. How long the Fed stays there remains to be seen, but don’t expect rate hikes any time soon, even with all the inflation ugliness.

Why? I see three reasons. First, the Fed spent the past nine months ushering homeowners with adjustable rate mortgages to safety by drastically cutting short-term interest rates. They did so to such an extent that many homeowners saw negligible rate resets in 2008, unlike the experience of their neighbors in 2007. This has prevented untold additional foreclosures and, given the significance of this relief, the Fed will be unwilling to throw those same homeowners back under the bus by raising interest rates too much, too soon.

Secondly, the weakness in the broader economy and the tenuous improvement in credit markets provides little latitude for the Fed to raise interest rates. And finally, the looming presidential election - although it shouldn’t factor into the equation - makes this a particularly sensitive time for the Fed to consider any interest rate increases. Can you imagine the field day the candidates would have if the Fed raised interest rates prior to the election? One other tidbit: The decision to appoint Ben Bernanke to another term as Chairman of the Fed, or not, will rest with the winner of the upcoming election (Bernanke’s term expires in 2010).

Don’t get me wrong. I’m not saying the Fed shouldn’t do whatever is necessary to tame inflation. (I personally think they should). But I am saying that it will be difficult for them to raise interest rates anytime soon, even if the inflation picture gets worse. The Fed continues to believe that inflation will moderate on its own, though you can sense some waffling in that stance as oil goes higher. Let’s hope they’re right.

The TreasuryDirect just announced the new I Bond rates today. The new inflation component is 4.84% which is about what had been predicted. The fixed rate had the largest drop it has ever had since the I Bonds started. It fell from 1.20% to 0%. The largest previous drop was in November 2001 when it fell from 3% to 2%.

The inflation component is combined with the fixed rate to give the total earnings rate. Due to high inflation we’ve been experiencing, the inflation component is a very high 4.84% so the the combined rate is a respectable 4.84%. However, with a 0% fixed rate, the earnings now will just keep pace with the government reported inflation (CPI-U).

With this new low fixed rate and the recent purchase limit reductions, these I Bonds have lost much of their appeal.

The Federal Reserve lowered a key U.S. interest rate by a modest quarter percentage point on Wednesday and hinted the move could be the last in a series dating to mid-September.

However, it kept its options open and financial markets saw some chance more rate cuts could be in store.

In announcing its decision, the U.S. central bank pointed to the “substantial” reductions it has already put in place and noted that energy and other commodity prices were on the rise. It also dropped a reference contained in its last interest-rate announcement that “downside risks to growth remain.”

“The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity,” the central bank said.

While the Fed said uncertainty on the outlook for prices remained high, it also said it still believed inflation would moderate over time, which some analysts saw as suggesting the possibility rates could move lower. Two Fed officials dissented from the decision to cut rates, preferring no change.

Federal Reserve cuts in the federal funds rate have an unpredictable impact on long-term mortgage rates. Rates may fall after this week’s rate cut. Or, they may rise, as they did following the Fed’s two January cuts.
How soon could it affect you?

Nobody really knows how soon the Fed’s rate cut will impact mortgage rates, or which direction rates will likely go.

For this reason, consumers are urged not to wait for the market to bottom before looking for a mortgage.
“I am absolutely a believer that taking action now makes sense.”

“I am absolutely a believer that taking action now makes sense,” says Bob Walters, chief economist at Quicken Loans.

Although rates have been trending higher in recent weeks, they remain low by historical standards. So if you’re looking for a mortgage, the time to act is now.

It’s a bit easier to determine when the Fed rate cut will affect borrowing costs on adjustable-rate mortgages: You are likely to see a benefit the next time your mortgage resets.

The Federal Reserve slashed a key interest rate by three-quarters of a point Tuesday, capping its most aggressive two months of action in a quarter-century in a battle to halt a spreading credit crisis. Wall Street loved it, bursting to its biggest gain in five years.

The strong Fed action seemed to convince investors, at least for now, that the central bank will do whatever it can to keep the country out of a steep recession. The Dow Jones industrial average finished the day up 420.41 points at 12,392.66.

The latest Fed move brought the federal funds rate — the interest that banks charge each other — down to 2.25 percent, the lowest since late 2004.

That’s important far beyond bank boardrooms. The reduction triggered announcements from commercial banks that they were cutting their prime lending rate to 5.25 percent from 6 percent. This rate is the benchmark for millions of business and consumer loans.

Ben Bernanke made it pretty clear last week that the Fed intends to cut interest rates again. A poor employment report this Friday could prompt the Fed to cut rates immediately rather than waiting until the regularly scheduled March 18 meeting. I hope it doesn’t come to that, but an overtone of weakness to this week’s economic data could bring calls from Wall Street for the Fed to do something pronto. As we’ve seen, the Fed has been willing to cave to such pressure.

In addition to Friday’s employment report, tomorrow brings the ISM Services Index. That same index ignited the recession concerns a month ago when it plunged sharply, showing a contraction in the important services sector of the economy. A similarly poor reading this month would bring out the economic boo-birds calling for the monetary policy equivalent of a quarterback change … in other words, an immediate interest rate cut. Lock in your rates now if you can, because the future doesn’t look pretty for savers.

The Federal Reserve is ready to lower interest rates again to brace the wobbly economy even as zooming oil prices spread inflation, Chairman Ben Bernanke signaled to Congress on Wednesday.

He is fighting to keep the economy afloat after mighty blows from the housing and credit crises, while trying to contain inflation.

For now, the priority is shoring up the economy, Bernanke suggested in an appearance before the House Financial Services Committee. He pledged anew to slice a key interest rate and help the economy, which many fear is on the verge of a recession, if not already in one.

“The economic situation has become distinctly less favorable” since the summer, the Fed chief told lawmakers.

Since then, the housing slump has worsened, credit problems have intensified and the job market has deteriorated. Bernanke said that combination of bad news has made people and businesses more cautious about spending and investing, further weakening the economy.

The country should prepare for “sluggish economic activity in the near term,” Bernanke said. Concern is growing about the possible return of stagflation, when stagnant growth is combined with rising inflation, for the first time since the 1970s.