Posted on: Wednesday, May 4, 2005
Bank deposit rates could also see boost
| • | Fed bumps up interest rates with inflation in mind |
By Deborah Adamson
Advertiser Staff Writer
The Federal Reserve's decision yesterday to raise interest rates will increase borrowing costs for consumers, but it could also help nudge bank deposit rates higher.
The Fed, signaling a bit more concern about rising prices, increased its key short-term interest rate yesterday for an eighth time since June and indicated it will probably keep pushing it gradually higher in coming months to keep inflation under control.
The Fed's move led major banks in Hawai'i and elsewhere to raise their prime lending rates to 6 percent from 5.75 percent. The prime, a benchmark for many business and consumer loan rates, is the highest since September 2001.
Indirectly, the Fed's move usually translates into higher rates on certificates of deposit and other deposit accounts paid by financial institutions.
But before consumers rush to their local bank to lock in a long-term CD, they should keep in mind that interest rates are expected to go up more.
"The expectation is the Fed will continue to raise short-term interest rates," said Paul Brewbaker, chief economist at Bank of Hawaii. "They are not done."
Greg McBride, senior financial analyst at Bankrate.com, recommends savers sign up for CDs with a duration of less than one year.
Depositors who want to stay invested yet be flexible enough to take advantage of higher CD rates as they become available might wish to consider laddering, said Ron Wall, extension specialist in family economics at the University of Hawai'i-Manoa.
"Laddering is sort of the universal strategy for people who need to stay invested but also want to have money available to be invested when rates go up," he said.
How it works: let's say you have $10,000 to put in a CD. You could divide it into four investments of $2,500 each. Put the first $2,500 into a three-month CD, the second into a six-month CD, the third in a nine-month CD and the fourth into a one-year CD.
When the three-month CD comes due, take the money out and invest it in a one-year CD. Not only are you getting some interest for your money now, but every three months you'll have money coming due that you can invest in a CD with higher rates.
Eventually, if CD rates move high enough to your liking, you should switch to longer terms, McBride said. You could split your money into five pots and invest each into one-year, two-year, three-year, four-year and five-year CDs. As each mature, put it into another five-year CD. Every year, you'll get access to part of your money.
But don't expect CD rates to move in lockstep with Fed rate moves.
That's because CD rates are determined by other factors besides rising interest rates: competition for deposits, both locally and on the Internet; a financial institution's need to raise deposits; and the performance of benchmarks such as Treasury bonds.
"When the Fed started tightening (raising rates) in the past year, deposit rates were kind of slow to pick up. The market (in Hawai'i) had been unusually liquid," the economist said.
A few years ago when the bear market for stocks began and Hawai'i's home prices had not yet taken off, people were "liquid" or staying in cash. It wasn't difficult for local institutions to attract deposits so it didn't feel the need to pay higher CD rates. But that's changing.
As the stock market recovered and home prices took off, residents started to move money into other investments. As such, financial institutions might offer higher rates to attract or retain deposits, Brewbaker said.
Reach Deborah Adamson at dadamson@honoluluadvertiser.com or 525-8088.
