Interest Rates Are Expected to Keep Falling
Interest rates are expected to continue their declines over the next several months, with the prime lending rate moving into single digits for the first time since 1978, government and private economists predicted Monday.
A drop in the prime to 9 1/2% from 10% could come as early as this week, in response to falling short-term rates on government securities and the weak second-quarter economic growth figures expected by most economists. Indeed, one small commercial bank in New York City, Freedom National, lowered its prime by that half a percentage point last Friday.
“The prime rate has some catch-up to do with what other interest rates are already doing,” said Kenneth T. Mayland, vice president and chief economist at First Pennsylvania Bank. “There’s a good chance it could go in the next couple of days.”
The prime, or base, rate is the benchmark used by banks to set borrowing costs for corporate customers. The most credit-worthy businesses pay less, while smaller companies pay a higher rate based on the estimated risk of the loan.
Yields Fall at Auction
The prime last fell a month ago, when it dropped half a percentage point to 10%, the lowest rate in more than six years. It has been declining regularly since last September, when it was at 13%. However, it has not been below 10% since October, 1978, when it began climbing to a peak of more than 20% in late 1980.
Meanwhile, yields on short-term Treasury securities fell to their lowest level in five years in Monday’s auctions. The Treasury Department sold $7 billion in three-month bills at an average discount rate of 6.73%, down from 7.21% last week. Another $7 billion was sold in six-month bills at an average rate of 6.9%, down from 7.35% last week.
The rates were the lowest since June 16, 1980, when three-month bills sold for 6.37% and six-month bills averaged 6.66%.
Economists generally expect interest rates to remain constant or continue to fall slowly throughout the year, with a small rise predicted at year-end. Consumer interest rates, which have not fallen in step with commercial lending rates, should begin to drop soon, they said.
The most closely watched short-term rates--Treasury bills, certificates of deposit and the federal funds rate--appear to be holding at 7.5% or below, leading most economists to predict further easing of credit by the Federal Reserve.
‘Flash’ Estimate Due
Some expect the Fed to lower the discount rate to 7% from 7.5% this week to match market rates. They say such a move would quickly be followed by a half-point reduction in banks’ prime rate.
“My guess is the banks are waiting for another signal from the Fed in the form of a cut in its discount rate. The markets are priced anticipating that,” said Irwin Kellner, chief economist at Manufacturers Hanover Trust Co. in New York.
Kellner said the Fed is likely to respond to the Commerce Department’s “flash” estimate of second-quarter growth to be released Thursday. The conventional wisdom is that the growth rate will be between 2% and 3% on an annualized basis, a weak performance by nearly everyone’s standards.
Growth figures in that range mask wide disparity between contracting sectors of the economy, such as manufacturing and agriculture, and faster growing segments, such as services and retail sales. The overall performance is referred to by some economists as a “growth recession.”
“I would think a discount-rate cut is likely to occur if the flash report coming out Thursday is disappointing--anything less than 2%,” Kellner said. “Anything greater than 2.5% would probably cause the Fed not to move. While it wants to avoid a recession, it doesn’t want to ease up more than it has to.”
Economists were divided over whether the widely expected cut in the prime will mark the bottom of the cycle or whether rates will fall further. None expressed the expectation that the prime would fall below 9%, however, and some forecast the beginning of an upward trend.
3% Growth Rate Seen
“I think the current rate (10%) or 9 1/2% is the bottom for this year. I’m looking toward higher interest rates over the next several months, rather than lower rates,” said Frank McCormick, vice president and senior economist at Bank of America.
Although the consensus among economists--if such a thing can be said to exist--is that the economy will poke along at about a 3% growth rate for the year, at least one said that things are bad now and getting worse.
“We feel the economy may already be in a recession. We’re looking for weakness throughout the year,” said economist Charles Larson of the New York consulting firm A. Gary Shilling & Co.
He forecast an anemic 0.8% annualized growth rate for the second quarter.
The good news, Larson said, is that slow growth will ease pressure on consumer loan rates, particularly auto and personal loans.
Credit-card rates probably will not change, however, because banks have little incentive to lower them and because card administration costs are high.
Kathleen Cooper, senior financial economist at Security Pacific Bank in Los Angeles, said consumers can expect to pay less for mortgage, auto and other loans for the rest of the year.
“There’s no question in my mind that, when the cost of funds goes down, they will follow. They are an intermediate (term) rate, not overnight, so they won’t move as far or as fast.”