In a surprise to no one, the Federal Reserve voted on Feb. 1 to raise its target range for the federal funds rate.
The increase of 25 basis points (0.25 of a percentage point) is the smallest hike since March 2022 but is hardly expected to be the last hike of 2023.
It puts the target federal funds rate in a range of 4.5% to 4.75% — the highest it’s been since 2007.
Why the change?
The goal of the Feb. 1 rate hike is the same as for the prior seven hikes last year: Bring down inflation.
The Federal Reserve, which is the nation’s central bank, is aiming for inflation to hover around 2% in the long run. Currently, the annual inflation rate is 6.5% — down from a high of 9.1% in June 2022 but still well above the Fed’s goal.
As the Fed said in a statement about its Feb. 1 decision:
“Inflation has eased somewhat but remains elevated. Russia’s war against Ukraine is causing tremendous human and economic hardship and is contributing to elevated global uncertainty. The Committee is highly attentive to inflation risks.”
What does it mean?
The federal funds rate is the rate that banks charge other banks for short-term loans.
When it’s rising, financial institutions tend to charge more interest on many types of loans and pay more interest on customers’ savings.
So a rising federal funds rate is bad news for folks with most types of debt because it means borrowing money will only become more expensive in the months ahead. (We get into the nitty-gritty of this in “6 Things That Are Getting More Expensive Amid Fed Rate Hikes.”)
Remember, the Fed’s goal is to lower inflation, which it does by slowing economic activity. And when borrowing money is more expensive, consumers tend to do less borrowing and thus less buying. That in turn tends to slow economic growth and lower demand — conditions that are conducive to easing inflation.
But a rising federal funds rate is good news for folks with savings because it means bank rates are likely to continue inching up in the months ahead.
Already in the past year, the national average rate on savings accounts jumped five-fold, from 0.06% in January 2022 to 0.33% this January — although you can easily earn 10 times that much or more at the most competitive banks.
Even the return on interest checking accounts edged up from 0.03% to 0.06% over the last year.
So if you haven’t shopped around lately to make sure you’re getting the highest return possible at the bank, now is a good time to take a look at what other institutions are offering.
Or, for a higher return than you are likely to find on savings accounts, look into money market mutual funds — which are Money Talks News founder Stacy Johnson’s favorite place to stash cash that isn’t invested in stocks.
As he recently wrote of money market mutual funds:
“They’re low-risk, pay whatever short-term rates allow and keep cash readily available.”
What happens next?
The next meeting of the Federal Reserve committee that controls the target range for the federal funds rate, known as the Federal Open Market Committee (FOMC), is March 21-22. That means March 22 is the next opportunity for the committee to vote to change the target range.
It’s a safe bet that multiple additional rate hikes lie ahead, with the committee stating Feb. 1 that it “anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.”