Fed leaves short-term rates alone

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The Federal Reserve has given at least a seven-week reprieve to credit card users, car-shoppers and people who are considering taking out home equity loans.

The Fed’s rate-setting Open Market Committee left short-term interest rates alone Tuesday. Loans tied to the prime rate — such as some (but not all) credit cards, auto loans, home equity loans and home equity lines of credit — will keep their current rates.

The rate-setting committee’s next scheduled meeting is seven weeks from now, on June 25-26.

The Fed kept the federal funds rate at 1.75 percent because the economy hasn’t recovered enough from last year’s recession to warrant raising the rate and possibly derailing the recovery.

The committee said that “economic activity has been receiving considerable upward impetus from a marked swing in inventory investment. Nonetheless, the degree of the strengthening in final demand over coming quarters, an essential element in sustained economic expansion, is still uncertain.”

The federal funds rate, also known as the overnight lending rate, is what banks charge one another for overnight loans. The overnight rate influences other interest rates, most importantly the prime rate, which is what banks charge to their best and biggest customers. The prime rate is 4.75 percent.

Few, if any, consumers are lucky enough to pay the prime rate for a loan, but variable-rate consumer debt such as auto and home equity loans, are based upon the prime rate. When the Fed raises the federal funds rate, the prime rate will rise by the same amount and those consumer rates will follow.

Economists, bankers and investors expect the Fed to raise short-term interest rates this year. The question is when that will happen. The consensus is that the Fed will raise rates at its Aug. 13 or Sept. 24 meeting.

The Open Market Committee’s next four meetings are scheduled for June 25-26, Aug. 13, Sept. 24 and Nov. 6. Futures traders at the Chicago Board of Trade have priced in an 8-percent chance that the Fed will raise the federal funds rate to 2 percent at the June meeting. Traders have set a 36-percent chance that the federal funds rate will be 2 percent by the end of August, an 88-percent chance that it will be 2 percent by the end of September, and a certainty that the rate will have risen by the end of November.

If futures traders are correct, the prime rate will be higher this autumn, and rates on some types of consumer debt will follow.

The exception is long-term rates, such as those paid for 15-year and 30-year mortgages. These are not affected directly by changes in the federal funds rate. Instead, long-term mortgage rates respond to changes in the yields paid on 10-year Treasury notes. Those yields are set by the market, which responds to broad economic factors such as inflation and unemployment.

The Fed cut the federal funds rate 11 times in 2001, from 6.5 percent to 1.75 percent, a 40-year low. The Federal Reserve controls the rate indirectly by adding and subtracting cash from the banking system.

Early this year, as the economic picture was brightening, investors and economists expected the Fed to start raising rates around now. But the economy hasn’t pulled out of last year’s recession as swiftly as many had predicted.