Banks Push Prime Rate Up to 10.5% : 4th Hike in Year; Key Interest Figure Is Highest Since ’85

Major U.S. banks raised their prime lending rates Monday to 10.5% from 10%, the fourth such increase this year, bringing the prime to its highest level since January, 1985.

Chase Manhattan Bank led in increasing the rate, which is closely watched because it is the benchmark for a wide variety of loans to medium-size and small businesses and consumers.

Quickly following suit were such large lenders as Citicorp, Bank of America, Manufacturers Hanover, Chemical Bank, Security Pacific, Wells Fargo and First Interstate.

Inflation Rekindled

The Federal Reserve Board has been tightening credit for the last eight months in an effort to contain inflation, which has been rekindled as the economy has strengthened. Many economists believe that key interest rates will continue to rise at least through the early part of next year and that the prime may cross the 11% mark within months.

“We think you’re going to see another round of tightening before these moves start the slowdown in borrowing that the Fed wants,” said Kenneth Ackbarali, senior economist at First Interstate.

The prime rate hike had been expected by the financial markets and had little effect on them. In stock market trading, the Dow Jones industrial average rose a modest 6.76 points for the day, closing at 2,081.44.

With the latest increase, the prime rate has risen a full 2% since early May, when it stood at 8.5%. The lending rate was increased to 9% on May 11, to 9.5% on July 14 and to 10% on Aug. 11.

Consumer Credit Affected

Many average consumers will feel the prime’s rise in the monthly payments they must make on the adjustable home equity loans that have become so popular in the last year and a half. The prime is also the benchmark rate for some adjustable auto loans, credit card interest rates and a few home mortgage loans.

This latest prime rate hike should be felt by consumers with adjustable-rate debt within 30 to 60 days, bankers said.

A look at a typical home equity loan shows what this year’s 2% increase in the prime would mean for some borrowers.

A consumer making interest-only payments on a $10,000 home equity loan would be paying $70.83 a month at an 8.5% rate but $81.50 a month at a 10.5% rate, according to the Federal Reserve Board.

Such increases may seem modest, and economists say this year’s rising rates have had very limited effects for most consumers. But the general upswing of rates may strain those consumers who have borrowed heavily and face hikes in floating-rate auto loans and adjustable rate home loans.

“When you add up increases from all the rates that are rising, a lot of people really are strapped,” said Mark Zandi, economist with the WEFA Group, an economic consulting firm in Bala-Cynwyd, Pa. “You may be socked by a bigger home equity loan, when you’ve got a bigger auto loan (payment) and an adjustable-rate mortgage that’s going up, too. It doesn’t take too much of a rise in rates to turn a lot of good loans into problems.”

And California will feel greater strains than other states, because California consumers have so eagerly embraced adjustable rate mortgages and adjustable home equity loans, Zandi said. Indeed, he said, California households are more hurt by rising rates than households in any other state because their interest-rate-tied consumer debt is so much bigger than their rate-sensitive investment income.

“These situations do cause special problems in California,” he said.

Economists said the general rise in rates has so far shown little sign of braking economic growth, even in such rate-sensitive areas as housing and automobiles. This is partly because the long-term interest rates that are used as benchmarks for conventional fixed-term mortgages have not risen sharply.

Housing starts, a key sign of interest rate sensitivity, are believed to have slowed somewhat in recent weeks but were strong as late as October. Housing starts rose a robust 9% in October from their September level, government statistics showed.

There are ample reasons for the Fed to fear a resurgence of inflation, economists say.

The nation’s factories are now producing at about 84% of their manufacturing capacity--about the level of 1979, when inflation roared. Companies in some industries, such as apparel, plastics, paper and chemicals, are already at the limits of their capacity.

Unemployment is at 5.3%, the lowest since the early 1970s, and there are signs that it may fall below 5% by the beginning of next year, Zandi said.

“There are signs that the factories are going to raise their prices and that the employers are going to have to raise their wages,” he said. “And that’s inflationary.”

Economists said that the prime rate hike was actually overdue, because banks have been paying sharply higher rates for the money they borrow.

Banks have tried to keep the prime rate 1.5 percentage points above the interest rate they pay on the money they borrow to make loans, economists said. Recently, they have been paying 9.5% for those funds, squeezing the “spread” to a narrow 0.5 of a percentage point, economists said.