Prime Rate Rises to 11.5% at Two Banks : Second February Hike Signals Higher Loan Costs for Consumers
At least two banks raised their prime lending rates to 11.5% Thursday, the second increase this month, sending a clear signal that consumers will face higher interest rates as the Federal Reserve tries to clamp down on newly resurgent inflation.
The prime rate increase of 0.5% came only a day after the Labor Department reported that the consumer price index had jumped 0.6% in January, the biggest monthly rise in two years.
That increase, combined with other data suggesting stepped-up inflation, prompted the Federal Reserve to nudge up a key rate affecting banks’ cost of funds, analysts said. The so-called federal funds rate, the rate charged on short-term loans between banks, rose to 9.5% Thursday.
Benchmark for Loans
The prime rate charged by commercial banks is a benchmark for many types of consumer and business loans, such as some adjustable-rate home mortgages and most home equity loans.
Banks set their prime rates based on their own costs of funds, including short-term borrowings from other banks and the interest they have to pay on savings accounts and certificates of deposit.
Chase Manhattan, the nation’s second-largest bank, led the prime rate increase late Thursday afternoon New York time. It was followed by Republic National Bank of New York.
Lynn Reaser, vice president and senior economist at First Interstate Bank in Los Angeles, said she expected many more commercial banks nationwide to follow Chase’s lead today.
Reaser said banks’ “cost of funds now is in the range that would certainly justify that level of prime rate.”
The increase raised the prime to its highest level in four years. The last increase, to 11%, was on Feb. 10.
In addition to increasing the cost of variable-rate loans, the prime rate increase is likely to bring higher fixed rates on new-car loans offered by auto makers, some economists said. Those rates have been held at artificially low levels in recent months in an effort to spur sales.
Economists said the latest inflation figures showed that the Federal Reserve’s efforts to slow the economy through gentle but steady rises in interest rates so far have had little effect.
“If you look at the Fed’s attempt to slow the system down, it hasn’t worked,” said David Rolley, senior economist at Drexel Burnham Lambert. “The economy looks like it still has plenty of steam left.”
Unemployment Remains Low
Despite tighter credit, unemployment remains at a 14-year low, factory utilization remains exceptionally high and durable-goods orders remain strong, although they have dropped from December’s very high rate, Rolley and other economists noted.
Although those factors are signs of a healthy economy, they indicate continuing strong demand for goods and services. That demand is putting upward pressure on prices.
As a result, many economists expect that the Federal Reserve will have to continue raising interest rates to combat inflation, leading to further increases in the prime in coming months.
Rolley predicted that consumer spending and economic growth generally would begin to slow only after long-term interest rates also begin to rise. The prime rate primarily affects short-term rates, such as rates on variable-rate loans that are adjusted monthly or yearly. Although variable-rate borrowing by consumers has grown rapidly in recent years, floating-rate debt made up only about one-sixth of the total $3.1 trillion of household debt at the end of 1988.
Neal M. Soss, chief economist at First Boston Corp., said that “there isn’t a twit of evidence yet” that the other recent rises in interest rates had done anything to slow consumer spending. The level of consumer spending is considered a crucial factor affecting inflation.
Although Soss, like other economists, foresees further hikes in interest rates, he does not expect them to approach the historically high levels of the early 1980s. Soss also maintains that the economy is strong enough to withstand higher interest rates without plunging into recession.
Long-term interest rates have been lagging well behind the rise in short-term rates. That phenomenon is reflected in the bond market. Bonds with long maturities--10 years or more--have been priced at much lower interest rates than short-term securities, creating an unusual condition market watchers refer to as an “inverted yield curve.” Such a curve is often viewed as a harbinger of a recession.
Bad News for Budget
Chase Manhattan’s prime rate increase was not announced until just after the stock markets closed Thursday, so it had no impact on closing stock prices. After dropping sharply Wednesday in response to news of the consumer price index increase, the Dow Jones Industrial Average closed Thursday at 2,289.46, up 5.53. The dollar rallied slightly against major foreign currencies in response to the higher interest rate.
The general increase in interest rates is considered bad news for President Bush’s budget proposals and for the federal government’s plans to bail out the ailing savings and loan industry. Bush’s budget proposals were based on optimistic estimates that interest rates would remain stable.
Federal Reserve Board Chairman Alan Greenspan on Thursday told Congress that higher interest rates are going to sharply increase the cost of the savings and loan rescue plan.
Greenspan said the Fed estimates that each percentage point increase in general interest rates will add from $3 billion to $4 billion to the thrift industry’s annual operating losses.
