Lower Rates May Prevent Slump Cheaper Borrowing Costs Could Stimulate Housing, Other Sectors

Like a powerful locomotive switching direction, longterm interest rates have lurched lower in recent weeks - a sharp reversal from 1994 that is sparking hopes of renewed stamina for the slowing U.S. economy.

If interest rates hold at these lower levels, several economists said Tuesday, cheaper borrowing costs for consumers and businesses could give a timely lift to housing and other industries that have been sapped of recent economic strength.

This view is by no means universal, since the impact of lower rates can take many months to be felt. In addition, some economists question the force of domestic interest rates on the U.S. economy, which is subject to a vast web of regional and global influences.

But a number of forecasters note that the beneficial effects already are rippling through key sectors - and some foresee even greater benefits over the long term.

Already, applications for new home loans in the last week of April were up 35 percent from a twoyear low reached late last year, the Mortgage Bankers Association said. In addition, applications for refinancing existing home loans have nearly doubled from a low reached early this year.

“The lower rates will prevent the economy from going into an economic recession,” said Sung Won Sohn, chief economist at Norwest Corp. in Minneapolis. He said that if not for the lower rates, the economy would probably start retracting in the last quarter of this year. A recession is defined as two consecutive quarters of negative economic growth.

While speculation about recession recently has grown, many economists are not convinced the economy is headed that way. Still, most say the drop in rates probably comes at a good time.

“There’s a very good chance the labor market will continue to slacken and such a development could adversely affect household spending,” said John Lonski, senior economist at Moody’s Investors Service. He said lower rates would help counter the weakness.

The decline in rates stems from a spectacular rally in recent weeks in the market for U.S. Treasury bonds, an important barometer of interest-rate trends.

Investors recently have gone on a bond-buying spree amid growing conviction that the economy is slowing to a pace that will not aggravate inflation. Inflation tends to erode the value of bonds, which pay a fixed rate of return.

The rally accelerated on Tuesday, with the price of the benchmark 30-year Treasury bond rocketing higher as its yield plummeted below the key 7 percent threshold for the first time in more than a year.

With the recent drop in bond rates, from a high yield of 8.16 percent reached on Nov. 7, the Treasury market has recouped about half the losses suffered in the dramatic bond slump of 1994.

The slump was triggered by the Federal Reserve’s decision in early February 1994 to start raising interest rates in order to check economic growth and thus thwart inflation pressures.

The recent plunge in bond yields has compelled banks and other mortgage lenders to sharply lower homeloan rates. In the past week, the average rate on 30-year fixed home loans dropped about one-third percentage point to 8.13 percent, according to HSH Associates, a Butler, N.J.based publisher of mortgage information. Many lenders are charging below 8 percent.

While the lower rates and increases in home-loan applications have yet to translate into increased home sales, it may be a matter of time.

“Once it starts getting out there that rates below 8 percent are available in certain parts of the country, that will certainly trigger interest” among some potential home buyers, said Paul Havemann, an HSH vice president.

“For someone who is that much on the edge, this could help them decide.”

Other sectors are also extremely sensitive to interest rates. Auto makers’ sales are dependent on affordable loan rates. Banks and securities firms also benefit from low interest rates.