For the past couple of months, the narrative describing the
outlook for interest rates has centered around economic growth and
the Federal Reserve's reaction to that growth. Now inflation has
added a new and potentially ugly twist to that narrative.
Anticipated growth drives a turn in interest rates
Since the end of April, some interest rates have been rising on
signs of economic growth. Most notably, job creation has picked up
steam -- the first half of 2013 was the best calendar half for job
growth since 2005.
Accelerating growth generally can make interest rates rise, and
this is especially true now because the Federal Reserve has held
interest rates down to stimulate growth. As that growth finally
comes through, it is anticipated that the Fed will start to ease
its stimulus. While Fed Chairman Ben Bernanke has recently sought
to soothe nervous investors by reassuring them that the Fed won't
ease short-term rates until growth is more firmly established,
longer-term rates will rise naturally as the Fed eases its asset
Inflation may force Bernanke's hand
The new twist came Tuesday when the Bureau of Labor Statistics
reported that inflation rose by 0.5 percent in June. That may not
sound like much, but it translates to an annual rate of more than 6
If markets were
nervous about rising interest rates
before, they may be even more jittery following this inflation
report. Inflation not only drives interest rates higher on its own,
but it could also force the Fed to be more aggressive about raising
interest rates in order to prevent price increases from getting out
So far, this flare-up of inflation is just a single-month event,
and short-lived inflation blips are not uncommon. However, energy
costs were the driving force behind June's higher inflation number,
and there hasn't yet been any sign of oil prices easing.
Consumers get bitten on both sides
As it stands now, consumers are getting bitten on both sides --
as savers and as borrowers.
As savers, consumers are stuck with
rates on savings accounts
, money market accounts and CDs that are near zero. Even with
moderate inflation, savings accounts were losing purchasing power,
and those losses will accelerate if inflation picks up faster than
bank rates rise. So far, that race is simply no contest.
On the borrowing side, consumers are already facing higher
mortgage rates. Banks have been quick to raise mortgage rates so
they don't get caught short as interest rates rise, and they will
be even more aggressive about raising those rates if there is a
whiff of inflation in the air.
Looking forward, if interest rates are pushed higher by
continued improvement in the economy, that will mean they are being
driven by demand, and there are certainly some benefits to that for
consumers. However, if rates are pushed higher by inflation, that
means they are being driven by fear, and that's not a good
situation for consumers.