Wholesale Prices, Prime Rate Climb : Lending Level of 11% Adopted by Major Banks

Signs of surging inflation helped lead many of the nation’s biggest banks to raise their prime lending rates half a percentage point Friday to 11%, the highest level in more than four years.

Continental Illinois Bank kicked off the move, announcing its new rate after the federal government reported a jolting 1% rise in wholesale prices for January. Other major banks soon followed, including Wells Fargo, First Interstate, Bank of America, Security Pacific, Citibank, Manufacturers Hanover Trust and Chase Manhattan Bank.

November Increase

The prime, a benchmark on which many consumer rates are based, was last increased on Nov. 28, when it was lifted half a percentage point to 10.5%.

The financial world has been studying the U.S. economy for signs that its continued robust growth would set off new inflation. Friday’s price report from the Labor Department convinced many that it would--and that the Federal Reserve Bank will soon raise short-term rates in an effort to brake any further rise in prices.

The price report and the prime rate increase were both bad news for President Bush’s newborn federal budget, which assumes that short-term interest rates will fall sharply this year. Higher rates will hurt the Administration because they make it more expensive to finance the federal debt, and, by slowing the economy, also have the effect of lowering tax revenues.

The new budget assumes, for example, that rates on 30-day Treasury bills will average 7.4% this fiscal year. They are now carrying a rate of about 8.5%, and Friday’s price report assures they will go higher.

Bush, when asked during a trip to Ottawa about the figures and how they might affect his budget projections, said: “You’ve got to wait to see how long interest rates stay different from that which we projected.

” . . . I’m not overly concerned about inflation in the United States. . . . We still have excess plant capacity. . . . It is important that we keep growing.” But he acknowledged: “I don’t like the figures.”

Many in the financial community had been expecting a rise in the prime rate, because recent weeks have already brought a sharp rise in more volatile short-term interest rates. Many economists predict at least one further half-point rise in the prime rate within the next several months, although many believe also that, by year’s end, the economy will be losing steam and interest rates will be falling.

Panel’s Decision

Meanwhile, records released Friday showed that the Fed’s key policy-making committee decided in December to push up interest rates in order to hold down prices.

A transcript of the secret meeting of the Federal Open Market Committee showed that the central bank committee voted 11 to 1 to tighten its limits on bank reserves, a move that has the effect of raising rates.

For millions of consumers, the latest rise in the prime means that they will have to make higher payments on their adjustable rate mortgages and home equity loans.

But analysts say that, so far, the upsurge of rates has had relatively little effect on consumer borrowers, just as it has not appreciably slowed the growth of the economy.

“Rates have continued to go up, but for the average consumer the effects have been pretty mild,” said Kenneth Ackbarali, senior economist with First Interstate Bank in Los Angeles.

The impact has been mitigated by the fact that so many mortgage lenders have been luring home buyers with low “teaser” starting adjustable rates designed to increase their market share in a highly competitive market, economist Tom Holloway of the Mortgage Bankers Assn. said.

A government survey showed that such initial adjustable rates averaged about 8.4% in December, compared to 7.8% in January, 1988. That rise is far less than the rise in comparable short-term rates, he said.

Rates on standard 30-year fixed-rate mortgages also have risen relatively slowly, for a different reason--the slow growth in long-term interest rates. The average 30-year fixed mortgage rose to 10.61% from 10.38% last year.

Other key consumer rates also have been resisting the general rise of short-term rates, said David Rolley, economist with the Drexel Burnham Lambert investment firm.

Banks, competing fiercely for customers, have continued to lower credit card interest rates very slightly--to an average of 17.77% last November from 17.8% at the beginning of the year.

Auto loan rates also have been moving up only slowly. Auto loans from banks ticked up to an average of 11.2% by the end of last year, from 10.5% at the beginning. And, in fact, the Big Three auto makers are financing some cars at rates below 6%.

Paul Getman, director of financial services at WEFA Group, a Pennsylvania economic consulting firm, said consumers have generally had it easy so far because the interest payments that consumers receive on their investments have been mounting faster than the interest charges they pay on their borrowings.

For example, rates on adjustable rate mortgages are increased only once a year, but interest rates paid on certificates of deposit or money market accounts are increased several times a year.

But such general considerations are scant consolation to consumers who took out adjustable mortgages several years ago “and just now are realizing how much they can actually rise,” he said.

Those feeling the pinch of the rate rises are disproportionately concentrated in California. The state’s population is younger, and thus more likely to be buying a house. Also, adjustable mortgages have been heavily promoted by the industry in California. About 80% of mortgages currently being written in California are adjustable, economists said.

Economists have been surprised by how little effect the rise in interest rates has had so far on business activity. “You’d be hard-pressed to find a financial sector that shows much impact from the last six months of hikes,” Getman said.

For signs of the effects of rate changes, economists watch activity in the housing industry. But the last available report, for December, showed a rise in home sales that took many experts by surprise.

About 4.09 million homes were sold in December, compared to 3.67 million in each of the preceding three months, economist Holloway said. “It was a shocker that people really struggled to explain,” he said.

Indeed, some economists, noting the continued low unemployment rate, believe that the economy has so much strength that the Fed will need to keep rates high at least through this year to tame inflation.