After almost three decades of slowly declining interest rates, the direction is beginning to reverse and we are about to begin a sustained period of rising interest rates. How high they will go is impossible to predict, but it is not going to be a short-term event. It will probably go on for several years because the Fed must keep inflation in check, although inflation is close to non-existent right now. But as the economy begins to improve, prices are going to start rising slowly but surely, so inflation will begin to increase. One certainty is that any increase in interest rates is going to be slow so as not to hinder the economic recovery in any way. But it is coming, and soon. Consider a few of the results of rising rates.
One of the first places it could be felt is in housing. Mortgage rates are already starting to rise, having risen a half a point since December. As mortgage rates continue to rise, and with the Federal Reserve having ended its mortgage buying program, there is a risk that the gains that have begun to appear may be reversed. Mortgage delinquency rates are still increasing, and mortgages with adjustable interest rates will have higher payments, possibly pushing more borrowers into default.
Car loans will become more expensive, creating some resistance to increasing car sales. Consumer spending, which has recently shown signs of life, could be negatively impacted because of increasing rates on credit cards which is already happening. There has already been a substantial amount of deleveraging on the part of consumers over the last year, often with emphasis on paying down credit card debt because it carries the highest interest rates. Since credit cards are used so often to make purchases, and if the unemployment picture does not improve more rapidly than expected, more motivation may exist to keep paying down the credit card debt, especially as the interest rates on the cards go up, continuing the restraints on consumer spending.
Now flip to the other side of the ledger. Almost as important as the consumer’s use of credit cards is the fact that approximately 50% of small businesses in the United States use a credit card for financing. Most of the time is because bank financing is not available. So the cost of financing is going to increase for many of these businesses putting yet more pressure on profits because raising prices to cover increases in costs has become extremely difficult in the current economic environment.
So rising interest rates, even though very slow, are going to be another drag on the economic recovery, both for small businesses and the consumer.