[See "Why the Fed's Move Came as a Surprise" on updated rate commentary]
Federal interest rates determined by the Federal Reserve are what cause interest rates on new credit cards, home mortgages, and even car loans to increase or decrease. When the day comes – because it will – that the Federal Reserve increases the Discount Rate / Federal Funds Rate ( the interest rate at which banks barrow money from the Federal Reserve), mortgage rates will also increase as banks will need to compensate for more expensive money.
Will Rates Increase?
The real estate cycle encompasses interest rates. However, the real estate cycle is by no means an exact science. It is an art. As with the ability of investors to foresee turmoil in the real estate market by noticing stalling sales prices, interest rate increases may also be forewarned by events in the global economy; primarily, inflation. There does not appear to be an exact method for determining exactly when interest rates will rise. However, inflation tends a contributing cause and indicator.
Inflation and Interest Rates
Inflation is measured in the United States by a Consumer Price Index, which is compiled by the Bureau of Labor Statistics. Simply, imagine a shopping cart that is filled with exactly the same items every month. The change in the total bill every month is what measures inflation (higher bill) or deflation (lower bill).
When inflation occurs, the United States dollar because weaker compared to other countrys’ currencies and foreign investing in the United States becomes more desirable. However, our domestic economy should be the utmost precedence. When inflation occurs, the cost of living for Americans increases and wage increases slowly follow. However, as wages typically increase less than prices increase, combating inflation while simultaneously stimulating growth is the ultimate goal. This is where the conundrum occurs. How do you stimulate growth and control inflation while increasing interest rates? As this a heavily debated issue, let us look to what other countries are doing.
Europe Raises Rates: USAToday Article: European Central Bank set to raise interest rates again. 7/6/2011
LONDON — The European Central Bank is set to raise interest rates again on Thursday and indicate that further increases are likely as it tries to dampen down high inflation despite the debt problems afflicting smaller countries.
Though higher rates may be necessary for a potentially overheating economy like Germany’s, they are likely to add to the growth concerns of some of the eurozone’s more indebted nations, such as Greece and Portugal.
How much inflation was Europe experiencing?
But the European Central Bank’s primary role is to keep inflation low by setting interest rates for the 17 countries that use the euro. With inflation at 2.7% — well above the target of just below 2% — the pressure is on the bank to continue tightening the monetary policy taps.
China Raises Rates: USAToday Article: China raises interest rates as part of inflation fight. 7/6/2011
BEIJING — China raised a key interest rate Wednesday for a third time this year as it tries to cool surging inflation.
How much inflation was China experiencing?
Inflation hit a 34-month high of 5.5% in May and is believed to have risen in June even as an overheated economy cools gradually under the pressure of investment curbs and other controls.
The benchmark rate for one-year loans will be raised 0.25 percentage points to 6.56%, effective Thursday, the central bank announced. The rate paid on deposits will rise a similar margin to 3.5%.
Why is Inflation Occurring?
Though the central bank is aware that much of the recent spike in prices has been due to energy and commodity cost increases it cannot control, it hopes that raising rates will prevent wages from getting too high. Pay increases tend to build in high inflation expectations into the economy.
USAToday Article: European Central Bank set to raise interest rates again.
Is there Inflation in the United States?
The United States inflation rate has risen every month in 2011. While the increases have started to slow down in the 3% range, our inflation rate will be an economic indicator to continue watching.
If rates rise as they have been in other countries, their actions may be indicators of what is to come in the United States.
The Bottom Line
If inflation continues to occur, interest rates may be risen slightly in an effort to curb inflation.
Keep an eye on the Federal Discount Window website for the current interest rates.
What Does This Mean for the United States?
No one knows exactly. However, if you are in the market to buy or are hesitating because of uncertainty, give your Realtor or financial planner a call. Interest rates are incredibly low now and housing markets are saturated with inexpensive homes. Remember, wise investors study and abide by the real estate cycle for their investing decisions.