Economists expect to see the Fed increase its fed funds target range by 25 basis points, to a range of 1.75 to 2 percent. But it could do so by pushing up the interest on excess reserves by 0.20 percent.
That’s because the funds rate has risen to the top of its range and the Fed would like to keep it more in the middle. The interest on excess reserves, or IOER, is the interest that the Fed pays banks to keep cash at the central bank.
Specifically, the benchmark is at 1.7 percent, just 0.05 points away from the IOER. The interest rate on excess reserves has historically been a guide for the funds rate and is usually a bit above the Fed’s benchmark. But Fed officials were recently concerned the funds rate is rising more quickly than expected, causing a tightening in money markets, according to the minutes from its last meeting.
A solution suggested at the meeting was that the Fed raise the rate paid on reserves by 0.2 percent, while it hikes the funds rate 0.25 percent. This could hold back the funds rate from getting too close to the target ceiling.
“We believe the 25bp hike in the target range will be implemented by increasing the IOER rate by 20bp, thereby encouraging the effective fed funds rate to trade closer to the middle of the 1.75-2.00% range,” wrote J.P. Morgan chief U.S. economist Michael Feroli.