I often get asked to explain how inflation and interest rates are related. I’ll dive into why inflation is a measure we’ll want to keep our eyes on, particularly when it comes to its influence on interest rates and bond prices. To summarize inflation, it’s the rise in the overall price of goods and services.
A strong growing economy typically drives up inflation as employees find work, wages rise, and people and businesses begin spending and investing more. In periods of economic growth, people and businesses also tend to borrow more money, leveraging economic good fortune. All of this drives up prices and contributes to inflation. Thus, central banks such as the Federal Reserve use Fed fund rates to control inflation. If economic growth accelerates too quickly, these banks can raise rates as a way to slow borrowing as well as economic growth. By making money more expensive (higher rates), economic expansion can often be kept in check.
In the U.S., the Federal Reserve has a directive to encourage full employment and keep inflation at a target rate of about 2 percent. In recent years, sluggish economic growth and weak employment conditions allowed rates to stay historically low as a way of encouraging investment and growth. Since inflation was below two percent, the Fed pushed rates to record-setting lows.
The Fed meets eight times a year to try to create a stable rate environment and steady economic growth. Should we enter a scenario where the economy is growing too quickly, the Fed would look to raise short-term rates again to tighten overall spending and keep inflation in check.
Keep in mind that rate hikes return the monetary policy back to normal and it’s not because the economy is growing too fast and must be controlled with higher rates. There has been speculation for quite some time that rates would go up, and until recently, we haven’t really seen an increase. Now, we’re finally seeing a gradual one, but that doesn’t mean it’s time to panic just yet. Mortgage rates aren’t that far off from their historic lows. Buying power is still tremendous and will be for some time.
If you’d like to run through a few scenarios based on today’s rates and your particular situation, give Fountain Mortgage a call.
This weekly Sponsored Column is written by the employees of Fountain Mortgage. Located in Prairie Village, Fountain Mortgage is dedicated to educating, and thus empowering, clients to make the best financial decision possible for their situation. Contact Fountain today.
Mike Miles NMLS ID: 265927; Fountain Mortgage NMLS: 1138268