Interest rate drop brings glint of hope to borrowers
Interest rates are tumbling. They are expected to drop further.
On Monday, Manufacturers Hanover Trust Company and Chemical Bank in New York, and Wachovia Bank & Trust Company, in Winston-Salem, N.C., lowered their prime rate - the rate commercial banks charge their most creditworthy customers - from 16 percent to 15.5 percent. That is the lowest level for interest on business loans since November 1980.
Only last week the prime at many major banks dropped from 16.5 percent, where it had stood since last winter, to 16 percent.
The prime rate often is the base rate from which other loan rates are calculated. For instance, some consumer loans are put at 5 or 6 percent above prime, and their charges may come down somewhat.
Some economists, however, say they believe interest rates will rise again later.
For instance, H. Erich Heinemann, an economist with Morgan Stanley & Co., a Wall Street investment banking firm, says interest rates will average 1 or 2 percent lower in the the current quarter compared with the second quarter. But he figures they will be up again in the fourth quarter before declining unevenly next year.
Mr. Heinemann is more pessimistic in this regard than other officers of his firm.
Lacy H. Hunt, an economist with the Fidelity Bank, Philadelphia, foresaw Monday's prime rate drop. But he expects it to bounce back to 16 percent by year's end.
For the time being, corporate borrowers are getting some rate relief. The prime rate drop reflects a slowdown in the demand for business loans, plus a reduction in the cost of money to banks.
Short-term money-market rates, such as those for Treasury bills, have fallen considerably. They averaged 12.21 percent in the four weeks through June 23. The four-week average to July 21 was 11.06 percent.
Long-term rates, however, have been taking their time in declining. Leif Olsen, chief economist at Citibank, New York, says he believes they are more influenced by the large deficits in federal spending. Fidelity's Mr. Hunt puts the deficit for fiscal 1983 starting Oct. 1 at $145 billion, with the federal government's total borrowing needs, including off-budget agencies, reaching $195 billion. This compares with US Treasury Secretary Donald T. Regan's estimate during the weekend that the fiscal '83 deficit will range between $110 billion to $114 billion.
If Hunt's estimate proves to be the case, homebuyers may get little relief from the high cost of mortgages. They'll be competing with the federal government for use of the nation's savings.
What can be done to speed the decline in long-term interest rates?
Mr. Olsen suggests that Congress pass a resolution providing explicit bipartisan agreement for a long-term effort through both fiscal and monetary policies for reducing inflation, and that this policy will not be reversed as it has so many times in the past. This, he states, ''would do a great deal to reduce the uncertainty about the political will and ability to reduce inflation.''
If people generally expect inflation to stay down, interest rates will follow. As it is, Mr. Olsen told the Senate Banking, Housing, and Urban Affairs Committee in testimony last week, the financial markets continue to behave as if they expect inflation will accelerate once again in the years ahead. This is reflected in investors' unwillingness to buy long-term bonds. They fear that history - a recession followed by another inflationary boom - will be repeated, he noted.
Morgan Stanley's Heinemann urges the Federal Reserve System to continue with its more recent moderation in the supply of reserves to the banking system. These reserves are eventually loaned to business and become money.
Heinemann points out a relatively new phenomenon in the money markets: When the Fed tightens up in the sense that the monetary base (bank reserves plus currency in circulation) grows more slowly, interest rates fall; when the monetary base grows rapidly, interest rates tend to rise. That is contrary to what used to be the case some years back. But investors in the money market have become more conscious of the influence of changes in the money supply or monetary base on future inflation and interest rates.
Thus, when the Fed was pumping up the monetary base at a 14.5 percent annual rate through mid-June of this year, short-term interest rates were higher than when the base declined at a 1.27 rate in the latest four weeks, Heinemann noted.
Citibank's Olsen says he believes that the Fed should provide some stimulus to the economy at this time. ''The economy is operating far below capacity levels,'' he says. ''Why anyone should worry about the money supply going above the Fed's money targets momentarily is strange.'' In other words, he agrees with the administration's standpoint that the Fed should keep the money supply growing at or somewhat above the 5.5 percent ceiling for the Fed target this year. He is somewhat concerned because the recovery seemed to stall a bit in June and early signs of July sales are not good.
Fidelity's Hunt is more optimistic. He notes that inflation-adjusted consumer purchases of goods and services grew at a 2.9 percent annual rate in the second quarter, slightly better than the 2.4 percent rate in the first quarter. He anticipates a 3.5 percent annual growth rate in the nation's total output this quarter.