Fed's Cut in Interest Rates Ripples Through Economy
IMAGINE a big bundle of money dropped in the center of a pool. After the cash splash, dollar bills float to the sides of the pool.
That's what has been happening since the Federal Reserve lowered interest rates another quarter of a percentage point Wednesday. In a monetary ripple effect, almost everyone comes out of the pool holding some money: The action will save the nation's credit-card holders about $650 million in lower interest rates. The monthly payment on a new $100,000 fixed-rate mortgage on a new home will fall $17. Those householders with home-equity loans will enjoy similar savings. Auto buyers will pay a few dollars less a month on a $20,000 car purchase that is financed.
And yesterday came fresh evidence of low inflation - a key to further rate cuts.
The Labor Department said consumer prices increased just 2.5 percent for all of 1995, the lowest level in almost a decade.
As the monetary ripple effect from the Fed's action continues, corporate treasurers will see some large savings too. Commercial banks quickly dropped the prime interest rate, charged to their better customers, from 8.5 to 8.25 percent.
The Fed's moves were eagerly anticipated on Wall Street, where the Dow Jones industrial average headed toward the 5,400 level after the Fed's announcement.
The central bank's move comes during a slack time in the economy. Consumers are staying away from malls. The industrial sector needs the oil of new orders. And new-home sales are slipping despite lower interest rates.
''In our view the Fed action was justified by the sluggish state of the US economy,'' says Donald Straszheim, chief economist for Merrill Lynch & Co. in New York.
Mr. Straszheim is among the economists who believe the Fed will have to continue to lower rates. This is the third reduction since last July. He predicts there will be three more quarter-point reductions by the Fourth of July. This would reduce the federal funds rate - the rate at which banks lend money to each other - to 4.5 percent. The prime interest rate would fall to under 8 percent.
Yet other economists doubt the Fed will act again for a while. Grady Means of Coopers & Lybrand Consulting in Washington does not see much economic weakness.
''My sense is that the economy is still pretty strong, and it's not clear any other reductions are necessary,'' says Mr. Means, who worked in the White House from 1975 to 1977.
The Federal Reserve, in its typical fashion, couched the rate reduction in terms of inflation. The Fed stated that the reductions could be made because ''moderating economic expansion in recent months has reduced potential inflationary pressures.''
Whatever the reason, it will be welcome on Main Street.
Credit-card debt cheaper
One of the first areas to feel the rate reduction will be credit-card charges, which account for 19 percent of all consumer payments. Most credit-card borrowers will see the rate reduction within about a month, since about 80 percent of all cardholders now pay variable rates on their debt.
With an average national balance of about $2,000, monthly savings are only about $5 per account.
''It's not anything earthshaking personally, but in the aggregate it brings down the cost to consumers,'' says Robert McKinley, president of RAM Research Corp. in Frederick, Md.
But the rate reduction may help some consumers who are deeply in debt. In recent months, the delinquency rate has been rising on credit cards.
The lower rates will also work their way into the housing market. The quarter-point reduction in rates will only mean a slight reduction in a monthly payment. However, the rate reduction is part of a continuing trend to lower rates over the past year.
With fixed-rate mortgages coming down to 7 percent from 9 percent a year ago, there are now an additional 7.6 million households that can afford to buy a moderate-priced home, estimates the National Association of Homebuilders (NAHB), a Washington trade group. Of that group, NAHB estimates that 431,000 are ''likely'' to buy a house.
Lower rates may also spark some refinancing, says Michael Carliner an NAHB economist. ''There may not be a lot of people with 11 percent mortgages, but the rates may convince some people to refinance,'' he says.
One of those people is Patrick Boyle, a resident of Lindenhurst, N.Y. Mr. Boyle still owns a house in Maryland. It has a 9.5 percent mortgage. ''It will bring down the monthly payment if I refinance, but the cost of refinancing may mean it's not worth it unless I keep it for another five years,'' Mr. Boyle worries.
Although the lower rates may help him sell the house, he says real estate brokers have told him that buyers are waiting for still lower rates. ''People seem to be getting greedy - if the rates move up soon, it might generate more activity,'' he adds.
Commercial banks are also likely to lower their rates on consumer loans. At Chemical Bank, a large New York consumer bank, Peyton Patterson, a senior vice president, notes that most consumer loans are linked to the prime rate. A typical $20,000 loan taken out to buy furniture would have an interest rate of prime plus 2.25 percent. Thus the potential savings on a 60-month loan would amount to about $2.35 per month or $141.05 over the life of the loan.