The Federal Reserve raised interest rates again on Nov 15, 1994, and, as a result, the housing market suffered. The government’s goal is to slow the rate of inflation, but higher interest rates will also affect consumer spending, which is expected to decrease, as a result. A slowdown is expected to arrive in 1995, and the furniture industry will lag behind the 10.3% growth recorded in 1993.
The Fed has been working overtime to slow down the economy–with limited success. The sixth hike in interest rates this year came on Nov. 15. This time the move was larger than the others at 3/4 percentage point. The Federal funds rate, the rate that banks charge each other, was raised to 5.5 percent. It started the year at 3 percent. This rate influences other short-term rates and major banks raised their prime lending rate to 8.5 percent. After the first five interest rate increases, most areas of the economy were still moving ahead at a healthy clip. In the Fed’s judgment, more tightening was needed to produce the kind of cooling off it deems necessary to prevent an acceleration in inflation.
The Elusive Slowdown
In the first three quarters of the year, real GDP grew at a 3.6 percent annual rate–well above the Fed’s target of 2.5 percent. Consumer spending, after a temporary pause in the spring, bounced back and has increased at a healthy 3 percent pace. In spite of higher interest rates, sales of durable goods remained strong–especially household related merchandise.
Consumer spending this fall appears to be only slightly less robust. Car sales keep rolling along. At retail stores, sales continue to be paced by double-digit gains at furniture and household equipment stores. Christmas sales promise to be good, although not a record breaker.
Housing Feels it First
The construction industry, however, is responding to higher interest rates in the predictable way. Both home building and business construction are weakening. Real spending on single-family homes dropped in the third quarter at an 11.4 percent annual rate while spending on office buildings fell 5.4 percent. New housing starts turned down in October with single-family starts at their lowest level since the beginning of the year.
A further weakening in the housing market is inevitable. Thirty-year fixed rate mortgages, which were 6.75 percent a year ago, are now a little above 9 percent. Housing affordability has taken a big hit. Monthly payments for a $200,000 mortgage are $280 higher than when the Fed started pushing rates up. Homeowners with adjustable rate mortgages will face increasing monthly mortgage payments. Mortgage applications have been on a steady downtrend. Both existing home sales and new home sales are losing their vigor.
Consumers to Feel the Pinch
Higher interest rates will mean that consumers will be paying out many more billions of dollars in interest than they did a year ago. That is money that will be diverted away from purchases of other goods and services. Consumers with adjustable mortgages, home-equity loans and auto loans will feel the impact the most. Interest charges on revolving credit will move up more slowly. These rates have been higher than most other lines of credit all along.
The level of total installment debt outstanding has jumped during the year by 14 percent. Debt now represents 15.3 percent of consumers’ personal income–up from 14.3 percent a year ago. Repayments will, therefore, also take an increasing share of people’s income.
The Slowdown Will Come
Even though the economy seems to be coping well with higher rates, the slowdown is on the way and will arrive in 1995. The softness that begins in the housing market will spread to other interest-sensitive areas. Auto sales will weaken. Major purchases for the home will also suffer some cutbacks.