SURPRISE MOVE. Prime hike will affect home loans; inflation next?
A $50,000 home-equity loan will cost an extra $10 a month. This is one result expected from a surprise move by banks to raise their prime lending rates from 7 to 7 percent. The rate hike, the first in 33 months, will be felt primarily by people who have taken out home-equity loans, which are frequently pegged to the prime rate. But it is not expected to affect the economy adversely.
``This will not result in a tremendous impact on consumer spending,'' says Martin Mauro, senior economist at Merrill Lynch & Co.
Because houses have appreciated so much, home-equity loans are now popular. Some economists say they believe the banks are raising their rates to increase their profit margins. By way of contrast, loans to business customers are down $5 billion so far this year.
The prime rate used to be the rate at which banks lent money to their best customers. However, today large corporations borrow money at lower costs, thus diluting the impact of a prime rate hike.
Even so, the rate rise, which Citibank and Chase Manhattan Bank started Tuesday, is creating a lot of confusion among interest-rate watchers, who are wondering if inflation will turn up on the prowl again and if interest rates will ratchet up.
They are also waiting to see what monetary course the Federal Reserve Board takes after its meeting earlier this week.
``This is not necessarily a watershed shift in the rate outlook,'' observes William Sullivan, a money-market economist at the Wall Street firm of Dean Witter Reynolds. Mr. Sullivan, who expects to see lower interest rates in the second quarter of the year, adds, ``There are many ways to interpret this move.''
For example, Lincoln Anderson, an economist at the Wall Street firm of Bear Stearns & Co., sees the rate rise as a confirmation of an improving economy. ``The first quarter is off to a good start,'' he explains, ``and the domestic economic situation argues for higher rates.'' The banks, noting the improved economy, ``saw it as an opportunity to move up rates,'' he says.
However, Mr. Mauro argues that the United States and world economies are still soft and the Fed remains concerned with the third-world debt bomb. As a result, Mauro doesn't think ``short-term rates will be up much more.''
Because of concern about the dollar's falling value and the world economy, some economists do not think the Fed will actively work to tighten interest rates following its Open Market Committee meeting this week in Washington.
``The Fed will tighten only as a last resort,'' predicts Mauro.
The declining value of the dollar will keep some pressures on the Fed. US interest rates are now 3.5 percentage points above Japanese rates, notes William Melton, senior economist at IDS, a financial services company in Minneapolis. Thus, Japanese investors theoretically could see the dollar fall another 35 percent before they start to lose money. Mr. Melton does not see ``an immense flight of capital.''