Originally created 05/02/04

Economists predict rise in interest rates for this year

It's not just gasoline.

A dozen eggs shot up nearly 40 cents nationwide in the past year and now costs between $1.50 and $2 at area grocers, while milk is on its way to averaging 70 cents more than last year's price, pushing above $3 a gallon.

And it doesn't stop with dairy products, either.

Prices for a growing list of goods and services from foodstuffs to clothes to hotel stays are going up each day. Raw materials and basic ingredients, such as scrap metal used in steel and soybeans found in pet food and Pop-Tarts, also are becoming more expensive.

Both business owners and consumers call the jerky price jumps a pain in the pocketbook. Economists call it inflation.

No matter how it's referred, the topic will take center stage Tuesday when Federal Reserve Chairman Alan Greenspan meets with his board of governors to discuss whether to keep interest rates at historically low levels or to start nudging them higher again after more than three years of cuts.

The group of central bankers typically meets eight times a year, and experts don't expect any change this go around. Still, the pricing pressures alongside an economy growing faster than expected and signs that companies are hiring again has industry watchers saying Mr. Greenspan might start his move sometime this summer. Until lately, most were forecasting next year.

"It could come as early as June," said Greg McBride, an economist for Bankrate.com, a Florida consulting and analysis firm. "A lot of it has to do with the high fuel costs we're seeing" - up more than 30 cents in regular unleaded gasoline since the start of the year.

The surging fuel prices make it more expensive to train, truck, ship or fly cargo around the globe, and the higher freight costs are being passed on to buyers. A weak dollar relative to other currencies also means importing those items has become more costly, stoking inflationary pressures even more.

That said, rising prices are another indication the economy is turning for the better, based on growth across a healthy sampling of sectors.

"Economists keep changing their forecasts for growth because we're moving along faster than a lot of us expected," Mr. McBride said.

THE ECONOMY GREW at an annual 8.2 percent clip in the third quarter of last year, the fastest pace in nearly two decades. Last week, a government report indicated the recovery was holding strong when it showed the economy grew 4.2 percent in the first quarter of this year.

While higher price tags bring small comfort to shoppers, companies welcome the news after years of stagnant prices have hampered profits. During the downturn, stiff competition and dampened consumer demand meant companies had to resort to salary freezes, layoffs or moving operations offshore to survive.

As with any rate move in either direction there are winners and losers.

Higher rates will make mortgages, car payments and credit card debt more expensive to pay off. Those who save, however, by putting money into bank deposits or buying CDs and bonds, will see a better return on their money. To understand why rates have to go up now, it's important to think about Mr. Greenspan and his Fed as the inflation police make sure prices aren't racing ahead too fast.

The bank's job is to corral price increases and prevent the double-digit inflation of the late 1970s and early 1980s brought on by soaring oil prices. It does so by setting rates to shadow inflation and control the amount of money flowing in and out of the economy.

High rates are initiated when inflationary pressure is high, and low rates follow when the pressure is low.

For example: When prices start to climb, as they are now, a corresponding Fed rate rise will make it more expensive to borrow. Shoppers may then think twice about slapping down a credit card because of the higher APR. The diminished demand will limit how far businesses can raise prices.

The era of cheap money of the past few years stems from a rapid succession of 13 rate cuts since 2001 that whittled short-term interest rates from 6.5 percent to 1 percent - the lowest level in 46 years. The cuts came as the economy floundered after the dot-com bust, and were introduced to spur spending.

A look at the mortgage market shows it worked. Rates on 30-year mortgages plumbed three-decade lows in March. The low borrowing costs sparked a rash of home buying and refinancing deals. In some cases homeowners traded in old mortgages for new ones more than once, taking the money they saved and spending it.

IN RECENT WEEKS, the sharp trend upward in mortgage rates has been just as telling because mortgages generally move in anticipation of interest rate changes.

And though inflation is wading ahead at a benign 1 percent to 2 percent, John Robertson, the head of regional research at the Federal Reserve Bank at Atlanta, says the bank neither wants to hold off too long nor move too early.

The Atlanta Fed is one of 12 Reserve Banks around the country.

Economists warn that when it comes to inflation, waiting to see the "whites of its eyes" is pure folly. At the same time, pulling the trigger too soon could kill the fragile recovery underway.

"We're seeing price blips in many sectors," Mr. Robertson said. "But sometimes those prices are reaching the consumers and other times they aren't being passed on."

Steel, he says, is a good example where rising prices aren't yet reaching the end consumer. Tough competition among middlemen manufacturers means they either bare the higher costs themselves or risk losing orders. But most agree it's only a matter of time before prices on anything from TVs and toaster ovens to office furniture and blenders move higher because of more expensive steel.

Another area yet to see pricing pressure is wages, which typically lags at the start of a recovery. When workers begin taking home bigger paychecks, it's thought, they will spend more and prompt prices to go up further.

Still, strong employment figures in March might have marked a turnaround on the way to salary increases. The economy created 308,000 new jobs that month - the biggest tally in four years - suggesting that companies are looking to hire.

"There's definitely a pent-up demand for salaries and compensation packages to go up, but many companies are still in a bunker mentality and are holding back," said Bill Coleman, an executive at Salary.com, which keeps tracks of wage developments. He said it usually takes six to nine months into a recovery before companies loosen the purse strings.

"Even though companies are conservative about salaries, there comes a point when they have to start hiring again and need to reward their workers or fear they leave for another job. That time is coming," he said.


An improving economy means increased demand and rising prices, which are soon contained by higher interest rates. Here's the effect:

Immediate winners: People who save. Money in bank deposit accounts will get a better return, as will investments in CDs and bonds when yields rise with rate increases.

Eventual winners: Workers. As the economy rebounds and company profits rise, corporations must hire more workers to grow and stay ahead of the competition or reward their current staff with raises and bonuses or risk losing them.

Immediate losers: Shopaholics. After years of gobbling up cheap goods, they will now have to be more selective.

Eventual losers: Consumers who rely on credit cards will have to rethink how much they want to charge once APRs begin to rise. Those financing car and home purchases also will have to shell out more in monthly payments. That should eventually slow the sale of cars and homes, and cut down mortgage refinancing.

Reach Matthew Mogul at (706) 823-3352 or matthew.mogul@augustachronicle.com.


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