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Rate reduction will trickle down to consumers eventually

Posted January 22, 2008 10:00 pm

Chris Dettro

By itself, the fact that the Federal Reserve cut the federal funds rate Tuesday by three-quarters of a percentage point to 3.5 percent doesn't mean much to consumers.

But what is sure to follow - a similar reduction in banks' prime lending rate - will translate into a reduction in consumer lending rates. Some will change more quickly than others, said Mike Houston, president and CEO of Town & Country Bank in Springfield.

The reduction in the Fed funds rate - the first to come between Federal Reserve meetings since September 2001, and the biggest reduction since 1990 - is designed to ease concern about a possible recession and quell a sell-off in global markets.

A rate cut tends to spur the economy by making it cheaper for businesses to borrow money and also will lighten the burden on people with credit card debt and mortgages with adjustable rates.

The fed funds rate is the rate banks charge each other for overnight loans. No consumer lending rates are tied directly to the overnight lending rate.

"What happens is when the federal funds rate is cut, banks will take a look at what their prime lending rate is and will make an adjustment," Houston said.

In addition to cutting the funds rate, the Fed said it was reducing its discount rate, the interest it charges to make direct loans to banks, by a similar three-quarters of a percentage point, pushing this rate down to 4 percent.

Commercial banks already have responded to the Fed's action on the funds rate by announcing similar cuts of three-quarter of a percent on their prime lending rates, the benchmark for millions of business and consumer loans. This drops the prime lending rate to 6.5 percent from 7.25 percent and eventually will mean a reduction in consumer lending rates.

Houston said commercial lending rates tied directly to the prime rate would be the first to be adjusted, with the effect of the Fed action being felt immediately. Home-equity loans with floating interest rates tied to prime generally are set on a monthly basis and won't be adjusted until the end of the month.

Home mortgage rates are favorable now, he said, and they usually are priced off the 10-year Treasury note.

"I'm not sure they could go much lower," Houston said, noting that 15-year rates at 4.875 percent and 30-year mortgages at 5.625 percent are low from a historical perspective.

"Credit card rates are really in the hands of the credit card companies," Houston said. "You would expect to see some reduction, but they're not tied directly to the Fed funds rate."

"They don't move as quickly and sometimes don't move at all," he said.

Ultimately, Tuesday's action will affect most interest rates, but some may take longer than others to creep into the market, Houston said.

"There is more impact at the short end of the market," he said.

Chris Dettro can be reached at (217) 788-1510.

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