Ask a Nerd: Will Interest Rates Continue to Rise?
No analyst or economist (or journalist) can know the future for certain. But if the past several months are any indication, it looks like we’ll continue to see a healthy increase in interest rates throughout the rest of 2022.
There are quite a few macroeconomy mechanisms that can affect interest rates. Let’s break down how these different factors affect whether interest rates will rise.
Interest rates usually go up when the Federal Reserve says so
Historically — and as shown this year by the many, many bank announcements and press releases we’ve received — when the Federal Reserve increases the federal funds rate, interest rates go up on products that you get from banks, like loans and deposit accounts.
While this means it can be more expensive to borrow money for major purchases like a car, house or home remodel, it also means that banks are likely to offer higher interest rates to customers on checking accounts, savings accounts and certificates of deposit.
This has been good news for me, personally, since my savings account interest rate has been boosted several times this year.
At NerdWallet, we’ve been keeping close track of changing interest rates on deposit accounts. Throughout the pandemic and in early 2022, interest rates were low; even most “high-yield” accounts had an annual percentage yield, or APY, of only 0.50% or so. In 2022, the Fed began a series of rate hikes to help slow inflation, which has created industrywide interest rate increases. Now we’re seeing some banks increase their interest rates significantly on checking accounts, savings accounts and certificates of deposit. Some are even breaking past 2% APY or higher.
What effect will high inflation have on my money?
Inflation can have a dramatic effect on the value of your cash, making it worth less as inflation goes up. Essentially, the price of consumer goods increases across the board, which means you aren’t able to buy as much with the same amount of money as you did before. For my budget, this has meant adjusting my grocery spending and trying to not drive as much so that I don’t need to spend as much on gas.
During times of high inflation, it might feel a bit pointless to keep your money in a bank account. After all, even a high-yield interest rate of 2% APY might not seem very high considering that inflation is currently 8.5%.
However, a high interest rate on your savings can make inflation less of a sticking point and help retain your cash’s value — at least, far more than keeping your savings in an account with a low interest rate.
Shopping around is a good way to take advantage of strong interest rates, Francisco Alvarez-Evangelista, advisor at the financial analysis company Aite-Novarica Group, said in an email.
“If this is something that is important to consumers, the digitalization of banking has made it easier than ever for consumers to shop around for the best choice and open a bank account online,” said Alvarez-Evangelista.
What happens to interest rates if a recession happens?
If the economy and labor market end up slowing too much, the U.S. could face a recession. During a recession, the demand for credit, such as loans, goes down because we are spending less and saving more. As the demand decreases, the Fed may choose to decrease interest rates to spur growth.
The word “recession” can trigger some anxiety for those of us who lived through the financial events of 2007-2009, but I have some good news from Jerome Powell, the chair of the Federal Reserve. Powell believes the U.S. economy is neither in, nor headed toward, a recession because the U.S. labor market is currently very strong. He also has said that a slowdown in the economy — while still maintaining low unemployment — can be good.
“We actually think we need a period of growth below potential, in order to create some slack so that the supply side can catch up,” Powell said in a news conference on July 27.
How can I weather inflation and a potential recession?
The No. 1 way to weather inflation and a potential recession is to boost your savings, if possible. We typically recommend that you keep three to six months’ worth of savings on hand for emergencies, which should help tide you over in case of a job loss. If that seems like too much, then start with as much as you can. You’ll probably feel better knowing that you have a bit of a cushion in case the economy slows down. Beyond that, you may want to take a look at your spending habits and see where you can be more strategic, noted Alvarez-Evangelista.
“Whether saving more in higher-interest bearing accounts, finding lower cost or generic alternatives, searching for deals wherever possible or enrolling in rewards programs to work towards discounts or free stuff, consumers should consider a full view of their existing financial situation and find ways to maximize their money, anywhere and everywhere.”
The economy may feel unpredictable at the moment. High inflation makes things more expensive, and high interest rates on loans can make it tougher to finance large purchases. If higher rates of unemployment were to enter the picture, then a recession would be likely. But no matter the scenario, it’s a good idea to shore up your financial security.
Chanelle Bessette writes for NerdWallet. Email: [email protected] The article Ask a Nerd: Will Interest Rates Continue to Rise? originally appeared on NerdWallet.