Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: THURSDAY, May 12, 1994 TAG: 9405120163
SECTION: BUSINESS PAGE: B-8 EDITION: METRO
SOURCE: Associated Press
DATELINE: NEW YORK LENGTH: Medium
Just when it seemed the economy had shifted into high gear, many economists caution that the Federal Reserve Board's recent policy of pushing rates higher could soon drag down corporate hiring plans, profits and consumer spending.
Potential early warning signs: Real-estate developers are cutting plans for new homes; businesses are feeling less confident about the economy; the bond and stock markets have been battered for the past three months.
``I think it could be a bombshell to come later this year,'' said Sung Won Sohn, chief economist at Norwest Corp. in Minneapolis.
``Right now, everyone is concerned about the economy doing too well and higher inflation. The way interest rates are moving, I wonder if we would have opposite concerns toward the end of the year.''
The warnings may shock many consumers and business leaders who have embraced recent reports of a newly vigorous economy, which added more than a quarter-million new jobs last month.
But cooling off the economy is precisely what the Federal Reserve had in mind when it began raising short-term interest rates in early February, reversing a five-year trend.
Since then, rates on 30-year fixed mortgages have shot up more than two percentage points to just under 9 percent this week, according to a survey of the nation's largest lenders by Bank Rate Monitor, based in North Palm Beach, Fla.
In same period, the prime rate charged by banks - the basis for many business and consumer loans - has jumped three-quarters of a point. Another round of prime-rate increases could come with the next Fed rate hike, expected within the week, said Bob Heady, publisher of Bank Rate Monitor.
The rate hikes are dampening activity in the construction industry. Nearly half of homebuilders surveyed by the National Association of Homebuilders said the recent rise in mortgage rates is hurting sales of new homes.
The Washington-based industry group is lowering its two-year projection for new homes by about 90,000 units, or 6 percent, to reflect the recent rate spike, executive vice president Kent Colton said.
One important source of savings for many Americans has dried up: The number of Americans refinancing their home mortgages - trading in a high-interest loan for a lower rate - has plummeted since its peak of last fall.
Of course, many savers stand to benefit from the recent spike in rates, but the trend has yet to show up in most bank money-market accounts. The rates paid on these short-term accounts has barely risen from the average of 2.33 percent recorded in early February.
Heady said the reason is that banks are trying to maximize their profits from the Fed's recent rate increases, by raising rates more steeply on business and consumer loans than on savings accounts.
The Federal Reserve's goal in nudging interest rates higher is to help curb potential inflation pressures. As the cost of borrowing goes up, businesses and consumers are less likely to take out loans. Reduced borrowing helps cool economic expansion that can result in higher inflation.
But interest-rate hikes themselves can be a form of inflation, said Sandra Shaber, an economist who specializes in consumer spending at WEFA, a forecasting and consulting company in Philadelphia.
``Mortgage payments are a big chunk of the cost of living,'' Shaber said. Outside the housing market and the recent plunge in financial markets, the impact of higher interest rates is hard to find.
But Sohn estimated that the Fed, by pushing interest rates up one percentage point, will cut employment in the United States by 640,000 jobs by year's end. So far, the Fed has boosted its target on the federal funds rate, a key short-term rate, by three-quarters of a point to 3.75 percent.
If the trend continues, about 2.2 million jobs could be lost by the end of 1995, Sohn said, adding, ``The impact is quite significant.''
Kevin Logan, chief U.S. economist at Swiss Bank Corp., said that higher borrowing costs could erode profits at large U.S. corporations by 10 percent by the end of the year.
by CNB