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Why does raising interest rates slow inflation and how will it affect me?

The Federal Reserve is expected to raise interest rates again, but the move could have unexpected consequences for individuals.

US financial news | Summary news 13 September

The Federal Reserve is attempting to slam the handbrake on the rapidly growing United States economy by introducing a substantial interest rate hike. We will soon find out if the interest rates increase to 5.5 percent, which would be the highest in 22 years.

The move will be announced on Wednesday, as part of a concerted effort to tackle inflation. The logic behind the decision is that high interest rates make borrowing less attractive and saving more profitable. It is hoped that this will cool the economy and bring down inflation.

But interest rate change remains a blunt tool to tackle a nuanced economic issue. We take a look at some of the consequences of the interest rate hike and how it could affect you…

How will it affect borrowing?

The benchmark interest rates set down by the Federal Reserve are applied to most loans in the US, meaning that the vast majority of borrowers will be affected. A higher interest rate means that you will have to pay back a larger amount when it comes to repay the money.

People with adjustable-rate mortgages will find that their monthly payments increase. The impact on fixed-rate mortgages is less clear but the interest rate hike is likely to push up the cost of the loans in the future.

How will it affect my savings?

If you’re hoping to put away a bit of money then now is a good time to do so because interest will accrue more quickly on any savings you have. This is precisely the point of an interest rate hike in the first place: encouraging consumers to save rather than spend, reducing the demand for products and hopefully bringing down prices.

How will it affect the job market?

Despite the pain caused by high prices and high inflation, the rapid growth has been a boon for the American jobs market which has recorded huge gains under Biden’s presidency. As the US reopens post-pandemic businesses are able to get back to normal and are looking to rehire for many of the jobs lost in early 2020.

However the growth of the past 12 months will likely be flattened by the interest rate hike. The purpose of the interest rate increase was to slow the demand for goods and services and stem the flow of money into the economy. With this in mind, companies are likely to slow the pace of hiring with fewer customers expected.