What the Federal Reserve rate hike means for savers

Federal reserve

The Federal Reserve gave personal savers two pieces of good news Wednesday. The first is likely to get the most attention, but the second could be more important.

First, the Fed's rate-setting committee, as had been widely expected, announced it was raising a key interest rate, the federal funds rate, by a quarter point.

Second, the Fed, the nation's bank for banks, revised its forecast for 2017 to include not two, but three similar rate increases over the course of the next year.

Speaking after the announcement, Fed Chair Janet Yellen downplayed the significance of the shift, noting that it only amounted to one additional quarter-point increase and was the result of a few Fed members revising their predictions upward.

But for anyone with certificates of deposit, savings or money market bank accounts, that modest shift upward in predicted rate increases could be significant.

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Where interest rates have been

Interest rates, as America's personal savers are painfully aware, have been kept near zero for the last decade as the Fed worked to spur the economy by making borrowing cheap.

In fact, Wednesday's quarter-point increase in the federal funds rate, the rate major banks charge each other when borrowing money, was only the second such increase in the last 10 years.

When borrowing money is essentially free, banks don't have to pay significant interest to lure people to put their money into savings.

The result of the Fed's policy has meant CD and savings account rates that have hovered at or around 1%.

That's a far cry from rates in 2007, just before the financial crash, when 1-year CD rates averaged more than 3.5%.

The first quarter-point federal funds rate increase since the crash came in December 2015, and the hope at the time was that it might begin to push savings interest rates higher. However, it had almost no effect.

The problem was rates have been kept low for so long that analysts believe it created a "new normal" in the industry that made banks reluctant to raise the rates for savings accounts and CDs.

Yellen and other members of the Fed have fed that psychology by repeatedly emphasizing that they expect to move very cautiously raising rates, which should be expected to remain below historical averages for some time.

Because of all this, the consensus among analysts was that it could take several rate hikes by the Fed before CD and savings interest rates begin to march higher.

Where interest rates are going

On its own, Wednesday's quarter-point increase might only have had a minimal impact on savings interest rates. But coupled with the forecast of three increases in 2017, it could provide a more significant spark.

Still, increases in CD and savings rates are likely to take some time and will require the Fed to follow through on its predictions in 2017.

Overall, the Fed's members now see the federal funds rate rising to 1.4% by the end of next year, 2.1% at the end of 2018 and 2.9% by the end of 2019. Longer run, they see it edging up to 3%.

Those rates remain relatively modest. But after a lost decade, they at least hold out the promise of a brighter road ahead.

That picture was also reflected in Yellen's overall assessment of the state of the U.S. economy.

She noted that, over the past year, 2.25 million new jobs have been created in the United States, and the unemployment rate fell to 4.6% in November.

In the past seven years, more than 15 million jobs have been added to the economy as the country recovered from the impact of the Great Recession.

"Our decision to raise rates should certainly be understood as a reflection of the confidence we have in the progress that the economy has made and our judgment that that progress will continue," she said. "It is a vote of confidence in the economy."

For personal savers, it's also a sign that Federal Reserve policy could finally begin to shove interest rates for CDs and bank accounts in the right direction.

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