Drop in Interest Rates Not Expected to Last : Analysts Predict Easier Credit Will Stimulate Spending, Pushing Rates Higher by Midyear
Recent declines in interest rates have spelled relief for home buyers, Third World debtors, corporate treasurers and the economy as a whole. But, like antacids for stomach pain, the relief won’t last forever, most economists say.
Rates will probably tumble a bit more in the coming weeks, they say, but eventually the lower rates will stimulate enough new consumer and business spending to force rates up moderately by midyear.
“The trend of rates is likely to tilt gently upward as the force of expansion . . . continues to prevail,” says Albert Wojnilower, chief economist First Boston Corp., the New York investment firm.
Most economists predict that the economy will grow about 3% to 4% this year, after adjusting for inflation, faster than the sluggish 1.6% annual rate in the third quarter of 1984 and the 2.8% rate in the Commerce Department’s “flash” estimate for the just-completed fourth quarter.
But that is sharply slower than the overall 6.7% rate for all of 1984, helped by the torrid 10.1% and 7.1% growth rates of last year’s first and second quarters.
Already there is some evidence that lower mortgage and auto loan rates have triggered a rebound in housing and auto sales. Industrial demand has picked up, and bankers say that business loan demand has also shown signs of a rebound, although not enough yet to match the rapid pace of early last year.
Some economists suggest that consumers may begin buying cars or homes soon, largely to avoid a return to higher interest rates later. Similarly, businesses are converting short-term debt into long-term debt to lock in the lower rates.
But a small number of economists say that acting now--simply to avoid higher rates--may be a mistake. They contend that interest rates will continue to fall significantly because the economy is teetering on the brink of a recession, or at least a sustained period of sluggish growth. Rates, they say, must drop much lower to restimulate economic growth.
Interest rates after adjusting for inflation “are high enough to bring the economy down,” says A. Gary Shilling, a New York economic consultant who predicts that the economy will enter a recession in the first quarter of this year. The prime rate--the benchmark rate that banks charge for business loans--will fall as low as 8% from its current 10 3/4%, he predicts.
These economists note that the Federal Reserve appears to be concerned about a possible recession and thus is continuing to ease credit conditions, as evidenced by its recent move to lower the discount rate to 8%. The discount rate is what member banks must pay to borrow funds from the Fed. The Fed also is concerned about the high value of the dollar, which threatens to prolong the slowdown by making U.S. exports more expensive and further bloating the record U.S. trade deficit.
Also, they argue, the annual inflation rate of 4% will rise only slightly this year, if at all, due in part to continued weakness in oil prices and the relatively high unemployment rate of 7.2% in November, which continues to moderate wage increases. Low inflation will allow the Fed to continue to ease credit, thus pushing interest rates lower, they say.
These economists add that the massive federal budget deficit will have little effect on interest rates one way or the other in 1985 unless there is a major change in the size of the red ink, because current interest rates already have accounted for the deficit.
“The budget deficit is a non-issue unless there is a change in policy,” says David A. Levine, chief economist at the New York investment firm of Sanford C. Bernstein & Co. Levine adds that any budget cutting this year will only affect the fiscal 1986 budget, since the 1985 budget is already set.
But economists were unable to accurately predict the behavior of interest rates in 1984, so their forecast for 1985 could easily be wrong as well. Early in 1984, the experts did not believe that rates would go as high as they did, and then later in the year they did not believe that rates would fall as sharply as they have in recent weeks.
Interest rates during 1983 were relatively stable and continued that stability through the first two months of 1984. But in March, rates began to edge higher, due largely to surging economic growth and business borrowing. The Fed, concerned about overly fast growth, also tightened credit to the banking system. The prime rate, which started the year at 11%--the same level it had been at since August, 1983--eventually rose to 13% in June.
The rising rates aggravated the Third World debt crisis and eventually began to slow the rapid pace of economic growth. By September, concern was growing that the economy was slowing too fast. Faced with little threat of renewed inflation, the Fed began to ease credit, triggering the current slide in rates.
The prime, down to 10 3/4% from 13% in September, could fall to 10% by midyear, predicts Daniel Van Dyke, senior economist at San Francisco-based Bank of America.
Rates on 30-year, fixed-rate conventional mortgages, now at 13.2%--compared to 14.68% in mid-July--also have room to tumble further. A 12% fixed-rate mortgage now seems quite possible and may spark a new housing boom, says Harold C. Nathan, senior financial economist at San Francisco-based Wells Fargo Bank.
“When mortgage rates get to that level, you have quite a response in increased home sales,” he says. “Twelve percent seems to be the trigger level.”
Introductory rates on variable mortgages could fall by as much as 2 percentage points, some economists say. Such rates currently vary between 10% and 12% in California.
Auto loan rates also may fall further from their levels of about 14% to 14.5%. And even credit card rates, now between 17% and 22%, may begin to tumble. Banks so far have generally avoiding lowering credit card rates, claiming in part that the costs of administering credit card loans are much higher than normal loans.
But if general interest rates fall further, “competition will pick up among banks to attract depositors and credit card business,” thus lowering credit card rates, Nathan says.
