On Wednesday, the Fed’s increased interest rates by 50 points. In lay man’s terms, interest rate went from 0.5% to 1% in the United States. This is the highest jump the US has seen in more than two decades.
In April, the bank of Canada also increased interest rates by 50 points to 1%.
Why are they increasing interest rates?
The main reason why interest rates are increasing is to tackle inflation (inflation is the reason why consumer items and everything is more expensive).
So confused, how did we get here?
I thought you wouldn’t ask.
2 years ago, when Covid hit and unemployment was high and things were just really bad. To stabilize the economy, the government pumped a ton of cash into the economy in the form of CERB, stimulus packages, low/interest free loans etc. $500 for you, $500 for me, everyone gets $500 meant most consumers and firms had more disposable income to spend on things.
Think about it this way, initial lockdown, the only thing we could buy was mainly groceries and as time went on, we could buy more consumer items, still couldn’t travel, go for concerts, shows and do all the social things you could normally do. But, your income more or less stayed the same and even increased for a bunch of people.
Excess demand for household items and things in general, coupled with supply chain issues (the pandemic made it harder for goods to be delivered to you & I as easily) and now the uncertainty that comes with a war in Ukraine, gas prices, everything is more expensive and prices of goods and services keep increasing at a rapid rate. Businesses aren’t being greedy, things are just as expensive for them too and they need to pass down those costs.
I get that, but how does that tie in with the interest rate hikes?
The Feds and central bank are hoping that an increased interest rate makes borrowing money more expensive for consumers and firms. When borrowing becomes more expensive, consumer and investment spending should reduce. That would push down the demand for goods and services (and the price – reducing inflation). But this isn’t certain- it may or may not work. The Fed is very optimistic that the economy can recover without going into a recession – time will tell.
What does the hike mean for me?
It means borrowing money is now more expensive than it was a few months ago or a year ago. This could affect any of the loans you have – mortgage, car loans, credit card, line of credit etc. The cost of debt is now more expensive. It also means if you have a savings account, it means you would get more interest payments on your savings accounts. For example, I recently got an offer for 2.7% interest on my TFSA. This is a huge jump from the 0.6% or whatever they were giving me – even prior to the pandemic. Now is a good time to build your emergency fund and other short term funds you may have because the interest rates are favourable.
Would you say I should pay off debt before saving with this interest rate hike?
Honestly, it depends on the type of debt you have and the interest on the loan. Rule of thumb, if the interest on the debt > interest made from saving, pay off debt first.
That’s it from me. What are your thoughts on all that is happening in the economy? How are you dealing with the interest rate hikes?
Looking forward to hearing from you.