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Federal Reserve announces an 0.75 percentage point rate hike, its biggest in 28 years: What that means for your money

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Key Points
  • The Federal Reserve announced its biggest interest rate hike in 28 years Wednesday.
  • The Fed raised rates by 75 basis points, or 0.75 percentage point, to a range of 1.5% to 1.75%, in an effort to tame historically high inflation.
  • "We at the Fed understand the hardship that high inflation is causing," Federal Reserve Chairman Jerome Powell said in a press briefing.

The Federal Reserve announced its biggest interest rate hike in 28 years on Wednesday. The central bank raised its target federal funds rate by 0.75 percentage points, in an effort to tame historically high inflation.

"We at the Fed understand the hardship that high inflation is causing," Federal Reserve Chairman Jerome Powell said in a press briefing. Inflation is costing Americans an extra $460 per month, according to an analysis by Moody's Analytics.

"The old maxim 'desperate times call for desperate measures' appears to have come into play with this latest rate move," says Mark Hamrick senior economic analyst at Bankrate.

Yesterday's interest rate hike is just one of a few future rate hikes on the Fed's agenda. The central bank said it expects the Fed funds rate to increase by roughly another 1.75 percentage points over the next four policy meetings, to end the year above 3%.

But nothing is set in stone: "The size and extent of future rate increases will remain highly dependent upon how inflation and the broader economy behave in the coming months," says Hamrick.

By hiking interest rates, the Fed is hoping to bring Americans relief from surging costs by tamping down inflation. Here's how a Fed rate hike works, and what it means for your wallet.

The Fed hikes interest rates to slow inflation

The Fed sets a benchmark rate that serves as a guideline for lenders, or banks, to set rates on loans of a certain length, hence the name "central bank." After yesterday's hike, the Fed is raising the rate banks charge other banks to lend money.

A basis point refers to changes in interest rates, so a 75 basis point hike is equal to 0.75 percentage point and sets the Fed's benchmark rates to a range of 1.5% to 1.75%. One basis point equals 0.01%.

An interest rate hike means you'll pay more to borrow money, whether by way of a business loan, an auto loan, a mortgage, or through opening a credit card. On the flip side, you can also earn a little more money on your savings when interest rates rise, although some banks tend to be slower to pass along those rate increases to customers.

The logic behind hiking interest rates is essentially that higher rates cause economic growth to slow. When businesses aren't expanding and growing, the hope is they'll have to lower prices to boost demand.

Borrowers: Pay down debt

The most notable effect of a rate hike: It will cost more to borrow money. The rates you pay on debt like credit cards, auto loans and mortgages are all influenced by Fed decisions. Credit card interest rates are especially sensitive, and tend to jump up quickly.

"The cost of borrowing is becoming more expensive, particularly for those with variable rate products," says Hamrick. "Fortunately, on the other side of the rate equation, returns on savings will likely be improving, particularly for those who investigate more generous high-yield savings options."

To prepare, experts suggest paying down credit card debt, since card rates quickly reflect broader hikes.

Savers: Hunt for higher rates

If you're setting aside money in a savings account or certificate of deposit, you might earn more interest on those balances, but this might not happen right away. Since some banks are slow to adopt higher interest rate perks, it can be beneficial to periodically hunt around to see if another bank is offering a more enticing rate on your savings.

If you can build your savings, even better. Some economists worry that the Fed's rate hikes could stall the economy, leading to a recession or stagflation, a period when the economy slows but prices remain high. Building up emergency savings can help you weather any financial impacts higher rates might have on the economy.

VIDEO1:0601:06
Suze Orman explains emergency savings

Video by Stephen Parkhurst

Investors: Stick with a 'well-diversified portfolio'

Interest rate increases "are prone to negatively impacting some subsets of the marketplace," Mike Stritch, chief investment officer at BMO Wealth Management told Grow.

That's all the more reason, especially if you're a long-term investor, to consider a well-diversified portfolio of stocks, bonds, and some cash to try and smooth out any outsized effects to one sector.

Check in on your portfolio to see if your holdings are sensitive to interest rate hikes, experts say —particularly long-term bond rates and technology stocks, which can be negatively affected by them.

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