The Federal Reserve raised short-term interest rates today, the ninth increase in a row. In other words, just a year ago (June of 2004), the interest rate was as low as 1 percent. With today’s increase, it stands at 3.25 percent. While it is only a 2.25% increase and that may not sound much, but if you were paying a $100 in interests on a loan, expect to pay over $300 now. In other words, over 3X. And that is what I intend to address in this article. What will be the impact of steady rise in interest rates and how to deal with them?
While the Federal Open Market Committee (FOMC) says that the the stance of monetary policy remains accommodative (in other words, the Fed would love to raise rates even more in the near future), higher interest rates curtail spending. The Fed admitted that energy prices have risen further, but argues that the expansion remains firm and labor market conditions continue to improve gradually. It added that pressures on inflation have stayed elevated, but longer-term inflation expectations remain well contained. To summarize, the Fed is trying to stop the economy from overheating by trying to maintain a balance, considering that we have huge budget and trade deficits to deal with.
So expect small (or as the Fed likes to say, “measured”) increases during coming months and hope that energy prices do not go up any further. If we can continue to grow at 3% plus rates, the US economy should be fairly stable. In its Monetary Policy Report to the Congress in Spring this year, the Fed said the same, “The fundamental factors underlying the continued strength of the economy last year should carry forward into 2005 and 2006, promoting both healthy expansion of activity and low inflation.”
What does it mean for you?
- The Fed doesn’t always get it right. While they are a bunch of very smart people, as I have always said, forecasting is not an exact science. It is almost like asking a six-year old how fast the economy will grow next year. So do not base your strategy on forecasts and projections about the future.
- Be realistic, watch the numbers carefully in real time, and respond to external environment as fast as you possibly can. Consider investing in a set of tools often referred to as “dashboards.” These tools will allow you to get a good understanding of where your business is at a glance.
- Oil (and energy) prices are expected to remain high during 2005-06 period. Coupled with higher interest rates, consumers’ disposable incomes will fall. They are more likely to defer or avoid making non-essential purchases. Consider offering no-interest financing options or delay in making any payments to motivate them to purchase.