Fed Funds or Prime?
The US Prime Rate is one of the most important interest rates to global financial markets however many consumers confuse the prime rate with the federal funds rate. When the FED announces a rate change how does this impact the prime rate? First, lets explain who really defines the prime rate for banks to base interest rates on.
The committee responsible for changing interest rates is part of the Federal Reserve known as the FOMC.
FOMC in an acronym for the "Federal Open Market Committee".
The FOMC holds 8 regularly scheduled meetings per year. At these meetings, the Committee reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth.
When consumers hear the Federal Reserve – more specifically the FOMC and more commonly referred to as the “FED” - is meeting to determine a change in interest rates its common to believe they are taking about the prime rate due to the prime rate’s popularity in our daily financial products.
However, when you hear reference to the “prime rate” or the “us prime rate” it is most likely the reference is being made to the US Prime Rate as listed the Wall Street Journal® – also known as the WSJ prime rate. The federal funds rate is what changes when you hear chatter about the Federal Reserve changing interest rates and not the prime rate.
The prime rate posted by banks averages around 3 percent over the federal funds rate. So, when the Federal Reserve announces a rate change it’s really to the interest rate banks pay to loan from each other - a consumers rate will be around 3% higher.
Common Question – The Fed lowered interest rates but the prime rate DID NOT move. Why?
Remember, as a guideline the prime rate is 3% greater than the federal funds rate but its up to the banks to change their posted rates and once 75% of banks introduce new rates then – and only then - will you see a change to the WSJ Prime Rate.
Probably the easiest definition for understand the movement of the Wall Street Journal’s prime rate is defined as:
” When 23 out of 30 of the United States’ largest banks change their prime rate, the Wall Street Journal then prints a prime rate change ”
Although many interest rates such as the LIBOR index can change daily the prime rate moves less often and is one of the most stable financial values for the global economy.
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