For consumers, Fed's expected rate hike is unlikely to cause shock and awe

Fed Chairwoman Janet L. Yellen has stressed that the Fed plans to move slowly so the federal funds rate, which is used to set terms for many consumer and business loans, would remain low for a while.

Dec. 15, 2015 3 AM PT

WASHINGTON — Federal Reserve policymakers are expected to end months of speculation Wednesday and raise a key interest rate for the first time in nearly a decade.

But for average Americans hoping for noticeably higher returns on their savings or fearing a sharp increase on credit card, auto loan or mortgage rates, the waiting is likely to continue.

“It’s much like that first dusting of snow,” Greg McBride, chief financial analyst for financial information website Bankrate.com, said of the much-anticipated Fed rate hike. “That’s not what cancels school and messes up traffic. But it’s the signal that winter’s coming.”

Fed Chairwoman Janet L. Yellen and her colleagues would be sending a symbolically powerful signal that they believe the economy finally has recovered enough from the Great Recession to start reversing seven years of holding the central bank’s benchmark short-term interest rate near zero.

But the increase in the so-called federal funds rate this week is likely to be minuscule: just 0.25 percentage point. The next similarly small move probably would not come until March or even June.

Yellen has stressed that the Fed plans to move slowly so the rate, which is used to set terms for many consumer and business loans, would remain low for a while. Low rates encourage consumers and businesses to spend rather than save, which boosts economic growth.

The small increase — coupled with the lingering effects of the central bank’s unprecedented stimulus efforts — would increase the typical delay it takes for consumers to feel any effect from a rate change, experts said. This time, the lag is expected to be lengthier because the rate has been so low for so long and the Fed is going to inch it up gradually.

“The rate increase is likely to be tiny, and I’m not sure it’s going to have an effect that will shock and awe anybody,” said James Chessen, chief economist at the American Bankers Assn.

The Fed’s actions also get diluted as they flow through the financial system, particularly to the savers who have been hardest-hit by the near-zero interest rate. Savers shouldn’t anticipate a bump in their balances any time soon because banks, squeezed by low rates and holding record-high deposits, aren’t eager to start paying out more to their customers.

The federal funds rate applies to short-term lending between banks from the reserves they hold at the Fed. But the rate affects other borrowing costs and has become a benchmark for savings accounts, certificates of deposit, credit cards, auto loans, small business loans and home equity lines of credit.

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The federal funds rate has less of a direct effect on longer-term loans, particularly mortgage rates. Those rates generally have already risen in anticipation of Fed action.

The last time the Fed began a period of rate boosts was in 2004, when it made a similar 0.25 percentage point move. It increased rates 16 more times over the next two years.

Rates on CDs with terms of up to a year increased just .03 percentage point after roughly a month, said behavioral economist Dan Geller, who analyzed the effects of the 2004 hike. The effects this time could be even smaller because the economy isn’t growing as fast as in 2004, he said. Rates on short-term CDs could rise just .01 to .02 percentage point, he said.

Right now, one-year CDs are averaging 0.27% interest nationwide.

“Even though it’s very, very likely that the Fed will move, it doesn’t mean that we should expect an instant increase in all rates across the board,” Geller said.

Interest rates on checking, savings and money market accounts didn’t rise for three to four months after that initial 2004 rate increase, and then only by 0.01 to 0.02 percentage point, he said. Geller expects a similar reaction this time.

Banks raise interest rates when they need to lure more deposits in response to higher loan demands, Chessen said. But after the financial turmoil of the Great Recession, Americans have sought the safety of government-insured accounts.

Deposits have grown at an average of about 6% annually since 2009. U.S. banks now hold $10.6 trillion in deposits, according to the Federal Deposit Insurance Corp.

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FOR THE RECORD

1:18 p.m.: A previous version of this article stated that U.S. banks now hold $10.6 billion in deposits. They hold $10.6 trillion in deposits.

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“In many cases, banks have a lot of deposits and they’re really waiting for real strong loan demand to be able to put those deposits to use,” Chessen said.

Banks also have been squeezed financially because the difference between the interest they pay on deposits and the rates they receive from loans have shrunk with the Fed’s near-zero policy. That margin hit a 30-year low in the first quarter of the year, the FDIC said.

When the Fed increases its benchmark rate, banks might try to pass it on to borrowers first to boost the margin.

“The banks are profit-making institutions,” said Donald Kohn, a senior fellow at the Brookings Institution think tank who was the Fed’s vice chair from 2006 to 2010. “They’re going to try to hold on to as much of the low deposit rates and slightly higher returns on their assets. But I think over time, competition for depositors’ funds will force the banks to offer more.”

That process could take some time, said Mark Zandi, chief economist at Moody’s Analytics.

For consumers, “the impact at least through much of 2016 will be very modest, almost imperceptible,” he said. “It’s really not until you get into 2017-18, when rates are a full percentage point higher, that people will begin to notice it.”

McBride said savers should shop for the highest rates they can find. At the same time, consumers probably will see rates on credit cards and home equity lines of credit rise more quickly, within one or two billing cycles.

“It’s good news to the extent they start to receive higher earnings on their savings,” he said of the effect of the Fed rate increase on Americans. “It’s potentially not good news if they have to pay higher interest rates on car loans or credit cards.”

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