Interest rates cut by Fed Third reduction taken to revive lagging economy

'Flat as a pancake'

Action expected to lower consumers' costs of borrowing

February 01, 1996|By Jay Hancock | Jay Hancock,SUN STAFF

Seeing faltering consumers, little job growth, tame inflation and election-year pressure, the Federal Reserve did the expected yesterday, cutting short-term interest rates for the third time in less than a year.

Combined with last year's rate reductions and expected future ones, the move is expected to trim costs for adjustable-rate mortgages, home equity loans, credit cards and other consumer borrowing.

The Fed lowered the key federal funds rate, which commercial banks charge each other for overnight loans, to 5.25 percent from 5.50 percent. It also reduced the more symbolic discount rate, charged to banks borrowing directly from the Fed, to 5 percent from 5.25 percent.

The intended effect: Stimulate spending and revive a sluggish economy.

"We think the economy's pretty much flat as a pancake," said David Donabedian, chief economist for Mercantile Bankshares Corp. "Signs of stagnation. Very weak consumer spending. The production side of the economy has really come to a standstill."

The stock market reacted positively, sending the Dow Jones industrial average to yet another record high at 5,395.30.

By themselves, yesterday's rate cuts won't touch most consumers immediately. But they amount to a nudge of monetary dominoes that will click through the economy over the next year and a half.

Several large banks lowered their prime rates yesterday to 8.25 percent from 8.5 percent. That will slightly reduce prime-based credit card and home equity lending in next month's bills or the month after.

"Plastic is largely tied to the prime," said Keith Gumbinger, vice president of HSH Associates, a Butler, N.J., firm that tracks rates. Credit card rates generally run 9 or 10 percentage points above prime.

Car loan rates, which have resisted the trend of cheaper money that started last year, may ease a bit, he added. New-car loans cost about 9.2 percent annually these days, only four-tenths of a percentage point less than they did in April, Mr. Gumbinger said.

Adjustable-rate mortgages will become less expensive. And if the economy continues to stumble, fixed, 30-year mortgages could fall below 7 percent by the end of the year, some economists said.

As household bills contract in the next months and bankers tempt business bosses with cheaper loans, "marginally, we'll get a little more consumer and business spending later this year and next year," said Allen Sinai, chief global economist at Lehman Brothers in New York.

For Maryland, parched from a drought in federal dollars, that may not be enough.

Its economy is subject to widely varying interpretations. Several analysts, including Michael Conte at the University of Baltimore and Mahlon Straszheim at the University of Maryland, discount government data showing that total Maryland employment has fallen slightly in recent months. Such net job loss, if genuine, would be a generally accepted sign that Maryland is in recession.

Optimists like Mr. Conte believe that statisticians are missing newly created jobs, that employment results will be revised sharply upward and that Maryland will book modest job growth of about 1.2 percent for 1995 and 1.5 percent for 1996.

But Charles McMillion, chief economist of MBG Information Services, a Washington-based business consultancy, takes the employment data at close to face value. "I'd be willing to make a rather large bet that job growth in Maryland, any way anybody wants to measure it, will not even be close to 1.5 percent in 1996," he said.

And the Fed action yesterday won't do much to help, he added. "It's not as much as Maryland needs, but it's a step in the right direction," Mr. McMillion said. "It's a little too late, but it's a welcome move."

This was the third reduction in the federal funds rate since July and the first reduction in the discount rate since 1992. For a year starting in February 1994, the Fed repeatedly raised the funds rate, moving from 3 percent to a high of 6 percent to try to put brakes on the budding economy and check inflation. The discount rate went from 3 percent to 5.25 percent.

Growth did slow, and now the central bank is trying to gun the engine again. The first quarter-point funds-rate cut came in July; a second, in December. Historically, the Fed has veered toward monetary lenience in presidential election years, and its moves generally come well before November.

If recession is the Fed's Scylla, price inflation is its Charybdis. So far, danger from the latter peril seems small.

The Labor Department said yesterday that wholesale inflation jumped 0.5 percent in December after rising by a similar amount in November. But the figure was dismissed as a blip.

"It wasn't a factor, because it was mainly caused by an increase in energy prices," which are more erratic than prices generally and should settle again, said Robert Sweet, chief economist for the financial management division of First National Bank of Maryland.

For all of 1995, wholesale inflation was just 2.2 percent. Final results aren't in yet, but economists expect that consumer prices rose by less than 3 percent last year for the fourth year in a row.

They think the country's economy is growing at an annual rate of about 1 percent now, slowing from a 3.2 percent annual rate last summer. A recession is generally defined as two consecutive quarters of shrinkage in the gross domestic product.

"The Fed should take no chances with this economy," Mr. Sinai said.

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