Inflation Throws a Curve at Interest Rates

Published October 05, 2012

| MoneyRates.com

If there's a major curve ball that's been thrown at the economy this year, it was the inflation report for August. Not that the economy has been on much of a hitting streak, but this inflation news is like a nasty curve that caught a struggling batter completely by surprise.

The Bureau of Labor Statistics announced September 14 that the Consumer Price Index rose by 0.6% in the month of August. What's so surprising about that? Well, it's the highest one-month jump in inflation in more than three years, and one of the highest monthly increases of the past decade. Also, it comes after a four-month period when inflation seemed completely subdued.

A bad time for price increases

To add some more context, the inflation report came out one day after the Federal Reserve announced its new program of quantitative easing. At that point, everyone assumed that the only challenge the Fed had to deal with was a chronically slow economy. That has proven a tough enough problem to solve, but dealing with inflation at the same time would completely change the game.

After all, rising inflation tends to push up interest rates, and low interest rates have been the Fed's number one tool for trying to revive the economy. What's worse for consumers is that the impact of inflation may not be the same across all interest rates. It is entirely possible that consumers may end up paying higher interest rates on loans, without receiving much more interest on their deposits. Here's how the impact of a slow-growth/rising-inflation environment could play out across three types of interest rates:

Savings accounts and other deposits. While persistent inflation would probably push CD, savings, and money market rates higher in the long run, those increases would probably trail behind the rate of inflation, meaning depositors would still lose purchasing power. The heart of the problem is that deposits have grown much faster than loan volume, so many banks have more money on their hands than they can use, and thus no reason to offer higher rates to attract more deposits.
Mortgages. Mortgage rates would either rise due to higher inflation, or loans would become harder to get because with current mortgage rates already roughly around the historical rate of inflation, lenders would not want to make loans at those rates with inflation rising. The market would remain tight until either inflation subsided again, or mortgage rates became high enough to compensate lenders for the risk of inflation.
Credit cards. Not only could inflation push credit card rates higher, but rising concerns about credit risk could cause additional rate hikes for many consumers. In other words, a combination of inflation and a weak economy could create two ways for credit card customers to lose.

It's too early to tell whether inflation is going to be a growing problem, or whether August's number was just a one-month fluke. But if inflation becomes a continuing part of the game, it may be tough for consumers to avoid striking out.

The original article can be found at Money-Rates.com:
Inflation throws a curve at interest rates

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