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NEWS ANALYSIS : Fed's Action Won't Derail State Recovery, Experts Say

November 16, 1994|JAMES F. PELTZ | TIMES STAFF WRITER

The Federal Reserve's aggressive interest rate hike Tuesday will put a crimp in the pocketbooks of millions of Californians but is unlikely to abort the state's modest economic recovery.

California businesses in such fast-growing industries as computer services are expected to continue investing and adding jobs, despite the rate increase, economists said. Higher rates also will help consumers who earn income from certificates of deposit and other fixed-rate investments.

In addition, because California's recession was worse than the nation's, and the state has been slower to recover, California still has more room to grow, even with higher rates, some economists said.

And while this was the Fed's sixth rate increase this year, rates still remain low by historical standards at this stage of an economic recovery, said Gary Schlossberg, senior economist at Wells Fargo Bank.

"We could probably absorb another percentage-point (increase) or two before the economy turns tail," he said.

"This rise in interest rates . . . is not sufficient to derail the recovery in California," said John O. Wilson, chief economist at Bank of America.

But the central bank's action Tuesday nonetheless will hurt many consumers and businesses because banks and other lenders will respond by raising their own lending costs.

That means borrowers can look for another round of increases on a variety of loans, ranging from home mortgages to auto loans to corporate credit.

In fact, some major banks, such as First Interstate Bank of California, immediately followed the Fed's move by raising their prime lending rates to 8.5% from 7.75%. The prime is the base upon which many consumer loans, such as home equity and auto loans, are tied.

The Fed's action also could push conventional 30-year fixed-rate mortgages, currently about 9%, closer to 10%, a double-digit level not seen in four years.

Because many fixed-rate mortgages are tied to market rates on long-term Treasury securities, their cost "has to do now with the bond market's reaction" to the Fed's steps, said mortgage broker Bob Sheets, owner of Golden West Mortgage Co. in Canoga Park.

On Tuesday, at least, the bond market applauded the Fed, and the rate on the bellwether 30-year Treasury bond fell to 8.03% from 8.07% late Monday.

And the mortgage market itself showed little change, because many lenders had raised their rates over the past few weeks in anticipation of the Fed's move.

Mortgage News Co. in Santa Ana, which tracks the rates of about 100 Southland lenders, said the average fixed rate on 30-year loans was 9.20% Tuesday, virtually unchanged from Monday but up from 8.86% just last month.

Analysts also expect higher adjustable-rate mortgages, which typically start three to four points below fixed-rate loans for at least a few months. That, too, would take cash out of homeowners' pockets.

"This is where the higher (rates in) adjustable mortgages begin to bite," Schlossberg said.

The rate increases could particularly hurt first-time home buyers, who this year have been a key force in the real estate market's sluggish rebound, said Connie Leyba, an agent at the real estate firm Keeler Dilbeck in South Pasadena.

She noted that the higher rates crowd out a certain number of first-time buyers by leaving them unable to afford a mortgage's monthly payments, even if they hope to use an adjustable-rate mortgage.

Realtor Ken Lowman of ERA Dahler Realty in Rancho Cucamonga, who has about a dozen sales pending, said many of his clients called him Tuesday about the Fed's announcement but that few were panicking.

Like many real estate agents, Lowman has been advising his buyers to lock in their mortgage rate as soon they turn in a loan application, to protect themselves if rates move higher before they close escrow.

"I've been doing some hand-holding, mostly with first-time buyers, but the majority of my clients aren't worried about rates going higher," Lowman said. "They already locked in their rate, so they don't have to worry about what will happen next."

Although the Fed's rate hike might cost consumers and businesses more, it won't be enough to snuff out the state's year-old climb out of the severe recession of the early 1990s, analysts said.

Business spending on expansion and new equipment, not consumer spending, is perhaps the driving force of California's recovery now, because it is generating job growth in such areas as computer services, health care and entertainment, economists said.

And business owners are making those investments because they see California's economy expanding further over the next year or two in spite of the rise in interest rates, said John Hekman, vice president of Economic Analysis Corp., a research firm in Los Angeles.

Times staff writer David W. Myers contributed to this story.

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