Rate hikes fail to gain traction

The Federal Reserve Bank's nearly yearlong effort to raise interest rates, designed to stave off inflation without choking off economic growth, is having a hard time taking hold.

Long-term interest rates, including mortgage rates, "by all rights ought to be going up," said Alan Day, the chief economist for TD Banknorth, a regional financial-services company headquartered in Portland. Market forces typically cause long-term rates to follow the short-term interest rates that the Fed directly controls.

But not this time.

"They're not doing what they want them to do," Day said.

That difficulty means interest rates are not having the kind of broad impact on the economy that was expected - at least not yet. As a result, the Fed has said it plans to continue with its "measured" pace for pushing rates higher, probably through the end of the year.

The Fed's board of governors is trying to rein in the economy before prices start jumping and wages gallop ahead, actions that might spiral out of control and derail the still-fragile recovery.

Last year, the Fed cut interest rates to 40-year lows, in an effort to stimulate the sputtering economy. More recently, as signs of inflation have appeared, the central bank has been moving interest rates upward in regular quarter-percentage point increments.

Of course, the Fed can't just order all interest rates to increase, however much it might wish it had that power. The lever it uses is called the federal funds rate, which is what banks charge each other on overnight loans.

That rate was cut repeatedly in 2002 and 2003 in an effort to get the economy moving. Eventually, it hit a low of 1 percent.

The federal funds rate influences a few other, mostly short-term, rates. The impact has been greatest on the prime rate - what banks charge most of their best commercial customers - which has risen from about 4 percent to 6 percent in response to increases by the Fed. The prime rate is a benchmark for the interest rates on many other loans, including home-equity loans or lines of credit that homeowners have used to tap into the rising real estate values.

But other interest rates are more resistant to the Fed's influence. Mortgage rates, for instance, are tied to the rates on 10-year federal bonds and investors seem to believe that inflation will remain relatively tame for the next decade, keeping those rates low. In response, mortgage rates have barely budged and generally remain below 6 percent, which has kept the real estate market humming overall.

However, home building seems to be getting off to a slow start this year, said Kevin Hancock, president of Hancock Lumber Co. Hancock said he thinks cool and rainy weather has been more of a factor than interest rates. He also said that high land and labor prices are playing a role in any slowdown in new home construction, outweighing a recent decline in lumber costs.

High interest rates are probably convincing some people to scale back their plans - perhaps a smaller addition or a less-expansive new house - but aren't likely causing many to completely drop a project, Hancock said.

In fact, if rates do rise, they tend to spur construction activity a bit, at least initially, he said.

Some people wait until they see rates start to rise before they lock in on a loan, Hancock said, to make sure that rates have bottomed out, and because they see that waiting even longer might mean higher rates. Likewise, when rates are falling, some borrowers tend to wait to see how low they'll go, he said.

"Interest rates on housing are very much a lagging indicator," Hancock said. "The impact on housing (construction) trails way behind changes in the interest rates."

He also said gentle increases have less of an impact than a sharp hike, though they still have an effect.

"It's at the margins - every time that interest rate goes up, it moves the affordable housing line a little, or forces a scaleback or reduction in size," Hancock said.

Jonathan Young, president of Young's Furniture Market in South Portland, said he thinks there's a general malaise in the economy that's having more of an impact on consumers than interest rates.

"Low interest rates were a nice positive" for a while, he said, but the increases have simply exposed consumer nervousness over terrorism, war and other global problems.

"Until we turn around this whole perception and think that the world's a better place, I don't think we're going to have a big economic rebirth," Young said.

Day said some of that generalized uncertainty afflicted businesses during the past three years of slow growth, and many firms decided that having some cash on hand was not a bad thing.

During the surging economy of the 1990s, many companies felt that cash was bad, something that should be used to buy other companies or to build a new factory, rather than sitting in a bank account.

But many companies have decided to build up their savings in the last few years because, when the economy is in a lull, there's no need to expand. That shift in strategy also means interest rates have less of an impact because businesses have less need to borrow right now.

Day, for one, thinks that people were a little bit spoiled in the 1990s and shouldn't expect that the economy will always be growing rapidly with low inflation.

"The economy is growing at a nice pace. It's just that maybe our expectations are a little greater," he said. "The 1990s were really a golden period."

What are people saying about mortgages today:

Rates on 30-year mortgages edged down last week to a seven-month low. Mortgage-giant Freddie Mac reported Thursday that 30-year, fixed-rate mortgages fell to 6.3 percent, down slightly from 6.31 percent two weeks ago. It put rates at the lowest level since they were at 6.24 percent the first week of March.

Bank of Hawaii, Central Pacific Bank, Territorial Savings Bank and Wells Fargo Home Mortgages all cut their 30-year mortgage rates to 5.75 percent this week.

Most people think of a mortgage as a means to an end. After all, you buy a house, not a home loan. But a mortgage is much more than the path to homeownership. It is a financial instrument that must be managed, just like any other financial investment.