Fed nudges rates up by a half-point

August 17, 1994|By John E. Woodruff | John E. Woodruff,Sun Staff Writer

Fighting to keep the economy from overheating, the nation's central bank boosted both of its key short-term interest rates a half-point yesterday. The move, the Federal Reserve Board's fifth since Feb. 4, touched off rallies in stock and bond markets but raised credit card and home-equity loan costs for millions of Americans.

Yesterday's decisions brought the Fed's target for the federal funds rate, which banks charge each other on overnight loans to meet reserve requirements, to 4.75 percent, and the discount rate, which the Fed charges to member banks that borrow from it, to 4.00 percent.

After the Fed's moves, banks across the country raised their prime rates, which largely determine the cost of borrowing for consumers and businesses.

The rate increases are likely to retard Maryland's slow-moving recovery, even though it may be good medicine for the national economy, which has been approaching growth rates that could ignite inflation, economists said.

"What you have to remember is that Maryland is in a very sluggish stage right now. The effect may be salutary in Utah or Nevada, where growth is very strong, but if you live in Maryland or Southern California, which are lagging behind, this is an unfortunate event," said Charles McMillion, president of MBG Information Services, a Washington-based consultancy that tracks the state's economy.

If the Fed's latest move convinces long-term bond investors that the central bank is serious about fighting inflation, and if that brings down mortgage interest rates, "there could be some mitigating effect" for Maryland by adding vigor to the state's housing industry, which has had an up-and-down year so far due to rising mortgage rates, Mr. McMillion added.

The bond market's first reactions yesterday were encouraging.

The yield on the benchmark 30 1/4 -year bond eased by more than one-tenth of a percentage point in the hours after the Fed's action became known about 1:15 p.m. But market analysts cautioned that the Fed's action in May produced a similar rally initially but then dissipated in volatile trading days later.

The stock market responded yesterday with a wilder ride. The widely watched Dow Jones industrial average jumped 20 points within minutes after the announcement, then lost 40 points in the next hour as computer programs spit out "sell" orders to take advantage of the gain.

But by day's end, stocks went back to their habit of tracking the bond market, and the Dow closed with a 24.28-point gain, to 3,784.57.

Maryland's Democratic Sen. Paul Sarbanes, a frequent critic of this year's Fed moves, denounced yesterday's increase, saying: "Economic growth will be slowed down; jobs will be lost. The Fed has engineered a slowdown in the economy despite the absence of an inflation problem."

The nation's largest banks, well prepared for the Fed's long-anticipated action, moved within minutes to increase their prime rates, which they charge to their best customers and which have become the key index determining rates paid by millions of credit card holders, many variable-rate home equity borrowers and some homeowners with adjustable-rate mortgages.

The prime went up a half-point, the same as the Fed's key rates, in most cases to 7.75 percent, its highest since the fall of 1991, when it stood at 8 percent.

Consumers will begin to feel increases on loans indexed to the prime in about a month, and all prime-indexed consumer rates will be adjusted to the new levels by the end of October, bank economists said.

But many forms of consumer credit, including new-car loans and possibly home mortgages, may not go up right away and perhaps not as much as the Fed did yesterday.

That is because banks, after drastically cutting payrolls and other costs, are finding that they have more money than they have borrowers and have been plunged into increasingly stiff competition for top-quality consumer loans this year.

"Believe it or not, we are charging less for a fixed-rate car loan today than we were in January," before the Fed began increasing rates, said Jay Cromwell, vice president for marketing at Mercantile Bank. A 48-month car loan with a 20-percent down payment goes for 8 percent at the Merc today, compared with 8.5 percent in January, he said.

Both the Merc and NationsBank said yesterday that they did not expect any immediate increases in new-car loan rates in response to the Fed's move.

The prospect on mortgage rates is less certain because long-term housing loans tend to follow the long-term bond market.

By Friday, average interest rates in Maryland on a typical 30-year mortgage were 8.65 percent, compared with about 7 percent in January.

That increase of 1.65 points was substantially more than the 1.25 points the Fed had boosted short-term rates between January and Friday, and the difference reflected the long-term bond market's fears that inflation was still a threat. It meant a family buying a house with a 30-year, $110,000 fixed-rate mortgage -- a typical housing loan in Maryland -- faced monthly interest and principal payments of $865 if they bought last week, compared with $739 in January.

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