Prime Rate Reaches 10%, a 3-Year High
Major banks on Thursday raised their prime lending rates half a percentage point to 10%, the highest level in three years, in a direct response to the Federal Reserve Board’s current effort to suppress inflation pressures.
The increase was the second in less than a month and the third since mid-May. Economic analysts said it was likely that the rate would rise further before the end of the year, helping to slow economic growth.
The prime rate is widely watched because it is used by banks and other lenders to calculate interest rates on a variety of business and consumer loans.
Chase Manhattan Leads Way
Chase Manhattan Bank, the nation’s second-largest bank in terms of assets, was the first to announce Thursday that it was raising its rate to 10% from 9.5%. It was followed by other major banks, including the nation’s largest, Citibank, and Manufacturers Hanover, Security Pacific National Bank, First Interstate of California, First National Bank of Chicago, Republic New York Corp., Continental Illinois National Bank & Trust Co. of Chicago, Chemical Banking Corp. and Irving Bank Corp.
The rate hike will lead to higher interest rates on a variety of consumer loans, including the increasingly popular home equity loans, as well as auto and personal installment loans. It also will eventually translate into higher interest rates on variable rate mortgages and lead to rising rates for new fixed-rate mortgages, thereby having a probable impact on the housing market.
Economists said the rate hike also would have a direct effect on small- and medium-sized businesses whose costs of borrowing are commonly tied directly to the prime rate.
Analysts such as Robert Dederick, an economist with the Northern Trust Bank in Chicago and a former U.S. undersecretary of commerce, said the fact that the prime rate had reached a double-digit figure could also have a psychological impact.
“It catches the eye,” he said, adding: “People get uncomfortable with double-digit interest rates--they’re accustomed to it being a signal that something was going wrong.” As a result, Dederick and others said, the hike may have the effect of slowing consumer spending.
However, the latest figures show that consumer spending probably was not affected by the last half-percentage point hike in the prime, on July 14. July retail trade figures came out Thursday, showing a 0.5% increase, fueled in part by strong automotive product sales.
Hike in Discount Rate Cited
The immediate cause of the banks’ move was a surprise decision by the Federal Reserve Board on Tuesday to raise the discount rate to 6.5% from 6%. The discount rate is the rate that the Fed charges its member financial institutions for loans. The move was widely interpreted as a sign that the Fed believes that the U.S. economy is growing too rapidly, threatening higher inflation.
The increase in the discount rate meant that the banks’ cost of funds had gone up. By raising the prime rate, they are passing the increase along to their customers.
The stock market on Thursday appeared to have already digested this week’s bad interest rate news and did not appear to be affected by the prime rate increase. The Dow Jones industrial average ended the day up 5.16 points, to close at 2,039.30, after plunging 44.99 points Wednesday.
Neal M. Soss, managing director and chief economist at the investment firm of First Boston Corp., agreed that the last increase in the prime had had little visible impact on the economy. But he said the jump to 10% and the other increases anticipated later in the year would probably begin to slow consumer spending by spring.
He said an effect on business operations probably would be seen in three to six months. He predicted a prime rate rise of another half of a percentage point or a full point by the end of this year. “I think the Fed’s on a path where the tightening isn’t over,” he said.
‘Sign of Prosperity’
Soss called the rising interest rates “a sign of prosperity.” Contrary to expectations, the economy has remained very strong after last October’s stock market crash, and employment figures are high. Even though increasing inflation is not yet visible, he said, the preconditions for it are present and that it is time to take preventive measures. June inflation figures, released last month, showed that the annual rate of inflation was about 4.4%, based on the consumer price index.
Some economists interviewed, however, said there is a risk that the Fed could miscalculate. “There’s always the danger that the Fed could do too much,” Northern Trust Bank’s Dederick said, causing the securities markets to overreact. But he said he thought it would take substantial further increases in interest rates before there would be any real danger of another stock market crash.
Walter Joelson, an economist and vice president at General Electric Co., said there also is a danger that higher interest rates will result in the value of the dollar continuing to rise. That could reverse the recent trend towards lower trade deficits because it would make U.S. exports more costly and increase the attractiveness of imported goods.
