Interest Rate Hike

In Depth

An interest rate hike occurs when the Federal Open Market Committee (FOMC) votes to raise the target range for the federal funds rate. Rate hikes are the Fed's primary tool for combating inflation: by making borrowing more expensive, the Fed reduces consumer spending, business investment, and overall demand in the economy, which puts downward pressure on prices. Rate hikes are typically implemented in increments of 25 basis points (0.25 percentage points), though the Fed has occasionally raised rates by 50 or even 75 basis points during periods of aggressive tightening, as seen in 2022-2023. The effects of rate hikes propagate through the financial system within days: mortgage rates, auto loan rates, credit card APRs, and corporate borrowing costs all increase. The impact on economic activity, however, operates with a lag of 6 to 18 months, creating the risk that the Fed may tighten too much before the effects are fully felt. Rate hiking cycles typically last 12 to 24 months and are followed by a pause period during which the Fed assesses whether it has done enough. For executives, rate hikes increase the cost of debt financing, reduce the present value of future cash flows in DCF models, and can trigger multiple compression in equity valuations.