Tea Leaf: Are higher interest rates coming sooner rather than later?

Published: Tuesday, April 12 2011 7:00 p.m. MDT

The globe's second most important central bank, the European Central Bank, which conducts a single monetary policy across Europe, opted as expected on April 7 to begin pushing its key rate higher. The ECB's key rate was boosted to 1.25 percent from an historic low of 1.00 percent, the first upward move since 2008.

The ECB's objective is to address inflation now exceeding a critical target of 2.0 percent annually. Additional tightening moves are expected in coming months, with the next move in June.

One major difference between the ECB and the Fed is the ECB's singular mandate to keep inflation under control. Two hyper-inflations in Germany following WWI and WWII largely account for the inflation paranoia.

The Fed's dual mandate is to address inflation, while also keeping an ear to the ground regarding unemployment. You can take it to the bank that the sharp decline in the U.S. unemployment rate from 9.8 percent last November to 8.8 percent in March provides the Fed greater flexibility to tighten policy than without such a move.

A boost for savers

The traditional viewpoint regarding Fed policy is that lower short-term interest rates help stabilize or stimulate the economy, while rising rates ultimately slow the economy. The reverse is all too true for those of retirement age who depend on interest income to help maintain solid or Spartan retirements.

One has only to ask their parents or grandparents about sharp cuts in spending tied to extremely low rates on money market funds, savings accounts and CDs and bonds. Millions of retirees "did all the right things" of saving diligently for retirement and shifting more of their funds from equities (stocks) to fixed-income (CDs and bonds) to minimize stock market volatility.

Rates on safe or U.S. government guaranteed short-term savings or money market funds earlier this year averaged 0.24 percent annually, one-tenth the level of late 2007, according to The Wall Street Journal. The reason? All short-term interest rates are indirectly tied to the 0.00 percent-0.25 percent federal funds rate.

Any decision by the Fed to boost its federal funds rate to 0.50 percent or 1.00 percent or 1.50 percent later this year or in early 2012 through a series of incremental steps would help address the Fed's commitment to keeping inflation under control. Such a series of moves would also lead other short-term rates higher.

For millions of retirees who primarily live on interest income, such moves can't come soon enough.

Jeff Thredgold is chief economist for Zions Bank and founder of Thredgold Economic Associates, a professional speaking and economic consulting firm. Visit www.thredgold.com.

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