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Although the Federal Reserve has raised interest rates 10 times since March of 2022 to a current target range of 5.00% to 5.25%, interest rates on traditional savings accounts have stayed stubbornly low. The average rate on savings accounts in June 2023 was 0.42%.That said, rates for many online high-yield savings accounts are paying more, coming closer to the Fed target rate.But that still doesn’t answer the question as to why interest rates on all savings accounts tend not to rise. To help answer that, here’s a look at how interest rates work and how you can find better rates for your savings.
When Do Interest Rates Tend to Go Up?
The Federal Reserve raises interest rates in periods of high inflation. The thinking is that by increasing the cost of borrowing money, business and consumer spending will decline, the economy will slow down, and prices will come back down.When the Fed raises rates, it can affect the interest consumers pay on mortgages, credit cards, car loans, and other forms of borrowing. On the flip side, when Fed rates rise, some banks will also raise the rates they pay on theirsavings accounts. Recommended:What Is an Interest Rate?
What Affects Interest Rates Rising and Falling?
To understand what makes interest rates go up and down, it’s important to understand the Fed. The Federal Reserve System, referred to as the Fed, is the central bank of the United States.The Fed sets the interest rate banks use to pay each other to borrow money. That rate, in turn, affects the rates consumers pay on their debt and what they may earn on their short-term savings.Depending on economic conditions, that rate may go up or down. To fight inflation, the Fed may raise rates. Alternatively, during times of recession and other economic problems, the Fed may lower interest rates in an effort to promote consumer and business borrowing and, in turn, economic growth.Here are some key things to know about what affects interest rates rising and falling.
The Federal Funds Target Rate
The federal funds rate is the interest rate set by the Federal Open Market Committee (FOMC), which is part of the Federal Reserve. The FOMC meets eight times a year to set the target rate. The target rate is the rate that commercial banks use to borrow and lend money to each other overnight.The target rate has varied widely in recent history. It hit a high of 20% in the early 1980s in response to inflation. During the Great Recession in the years 2007 to 2009, the rate was slashed to a record low of 0.05% to 0.25%.
Demand for Savings Bank Deposits
Banks use customer deposits — the money you put in your savings account — to make higher interest loans, such as personal loans, car loans, and mortgages.With people saving more during the pandemic, banks have seen their deposits skyrocket. The result has been that many institutions don’t need to attract checking and savings customers with competitive interest rates because they already have plenty of cash on hand.And it’s not just a pandemic thing. Ever since the financial crisis of 2008, banks have seen a surplus of deposits and haven’t needed to provide competitive rates. That’s one of the reasons traditional savings account rates have been so low for so many years.Another factor: Banks that have paid competitiveinterest rates in the past may be using the current hikes to make up for the lost profits during that time and, as a result, they’re now holding back on increasing savings yields.
Quantitative Easing
Quantitative easing is a form of monetary policy that the Fed and other central banks use in times of very low interest rates when economic growth is stalled. The Fed purchases securities on the open market to increase the money supply available to banks, which, in turn, encourages lending, investment, and hopefully economic growth.Recommended:LIBOR vs. SOFR and the Transition to SOFR Explained
Do Savings Account Interest Rates Ever Go Down?
Yes. As discussed above, the Fed often lowers interest rates in times of recession and other economic turmoil to stimulate growth. In turn, banks lower the rates they pay on savings accounts. As we saw before the recent rate hikes, interest rates on savings accounts stayed at historic lows for decades.Now that some banks are raising their rates, we may see those rates decrease again if inflation declines and/or a recession occurs and the Fed lowers its target rate.
How Much are Interest Rates Likely to Increase?
It’s likely that consumers may see some increases in their traditional savings interest rates as banks compete for deposits and catch up to the Fed’s increases. That may happen even though it’s expected that Fed rate increases will slow in the near future if inflation continues to slow, as well.
Is a Savings Account a Good Choice During Times of High Inflation?
It can be. If you put your savings into an account that’s paying a rate in line with the Fed target rate, you may find that the extra earnings on your savings can help take some of the sting out of the current rising prices.A savings account with interest can also be a good place for emergency savings and other short-term savings goals.
Types of Savings Accounts with High Interest Rates
If you’re looking for the best rates, you’ll likely want to look at online savings accounts. Online banks tend to respond more quickly to Fed rate changes. That’s because there is more competition among internet-only banks for customers and they don’t have the same amount of overhead that brick-and-mortar banks do.You also want to look forhigh-yield savings accounts when searching for the best rate. This is a federally insured account that earns a higher interest rate than a traditional savings account. High-yield accounts are most often found online.Whether you currently bank at a brick-and-mortar or online institution, it’s important to remember that banks don’t always increase their rates at the same time or with the same frequency as the Fed. Don’t assume that because the Fed is raising rates that your savings account rate has increased, as well.
The Takeaway
Most traditional savings account interest rates haven’t risen much lately, despite the fact that the Federal Reserve has aggressively increased its federal target rate. However, many banks, especially online, are offering increased annual percentage yields (APY) on high-yield interest accounts.Understanding how interest rates work and why your bank account rates may not be rising can help determine if you should make a change.Search high-interest savings accounts with Lantern by Sofi to help you find the banks that offer the most competitive rates.
Frequently Asked Questions
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Photo credit: iStock/AleksandarNakic
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About the Author
Walecia Konrad
Walecia Konrad is an award-winning financial journalist with 25 years of experience in print and digital media. She is a graduate of Syracuse University and specializes in the topics of health care, personal finance, and employer-sponsored benefits. Konrad's work has been seen on CBS MoneyWatch, The New York Times, Money, SmartMoney, BusinessWeek, and Forbes. She has been the recipient of both a Pearl Award for Best Web Publication of the Year and a National Magazine Award for Personal Service.
