Interest rate hike may stifle inflation in Hawai'i

By Deborah Adamson
Advertiser Staff Writer

A widely expected interest rate increase by the Federal Reserve today, aimed at curbing price pressures in the nation's economy, also should help prevent inflation from worsening in Hawai'i.

The rate increase will boost returns for savers while driving up borrowing costs for everything from small business loans to credit card debt.

Economists believe the Federal Reserve's Open Market Committee will vote in favor of a quarter-point increase in its benchmark federal funds rate. The federal funds rate, which has a strong influence on other rates Americans pay, is at a 46-year low of 1 percent.

"There's a particular interest for us in Hawai'i. Hawai'i's economic performance has been distinctly stronger than the national average," said Paul Brewbaker, chief economist of Bank of Hawaii. "The inflation ... the Fed is focusing on has already become a problem in Hawai'i."

In the second half of 2003, the rate of inflation in the state tripled to 3 percent from 1 percent a year earlier, Brewbaker said.

The central bank is scheduled to announce its decision today at the conclusion of a two-day monetary policy meeting.

Analysts believe the rate increase will be followed by others in the coming months, although there is dispute over just how fast and how high the Fed will want to push rates, especially in an election year.

As rates rise, businesses will find it more expensive to borrow money for expansion or other purposes. But that depends on how much the Fed raises rates beyond the quarter point expected today.

"Interest rates are still relatively low and borrowing continues to be very attractive," said Ed Pei, an executive vice president at First Hawaiian Bank.

Bank of Hawaii, First Hawaiian Bank and other financial institutions normally adjust their prime rate soon after a Fed move. The prime rate is the interest rate they charge their most credit-worthy borrowers.

For savers and borrowers, the Fed's move will hit their pocketbooks, for good or ill.

One loser is the debt-laden consumer who likely would see an increase in interest rates on credit cards.

"It could be really devastating to someone on the edge," said Wendy Burkholder, executive director of the Consumer Credit Counseling Service of Hawaii, a nonprofit Honolulu agency that assists debt-laden consumers.

The average debt of its Hawai'i clients is $18,000, spread out among eight credit cards, she said.

"Low interest rates are hurting all the people that are retired ... It's costing me $4,000 a year that I was getting before," said the 87-year-old Manoa resident, who has seen the rate he earns on his deposits shrink to less than 1 percent from about 4 percent to 5 percent three years ago.

Greg McBride, a financial analyst at North Palm Beach, Fla.-based Bankrate.com, noted that it took 13 Fed rate cuts to get interest rates this low.

A rate increase would be "a welcome turnaround for yields on deposit products," he said.

His advice to savers: Don't lock in money for longer than one year because interest rates will probably continue to rise. For those with credit card debt, he advises them to reduce their balances now.

A Fed increase would make it more expensive to get an auto loan. But because the monthly increase in payments would not be excessive, consumers should not necessarily rush into a loan just to lock in at a lower interest rate, according to McBride.

Unlike home mortgages, where a percentage point increase could make a big difference in monthly payments, the same increase on a $25,000 auto loan financed over five years would boost payments by only $12 a month, McBride said.

But the rate increase won't affect student loans yet, according to Bankrate.com. Interest rates on student loans are based on market rates of the past six months. The next annual adjustment for student loans is July 1, in which rates will actually decline to as low as 2.77 percent for Stafford loans and 4.17 percent for PLUS loans. Those with several student loans should consider consolidation.

As for real estate, rising mortgage rates are expected to have a cooling effect on the hot housing market in Hawai'i and elsewhere.

"Higher interest rates normally slow down the number of transactions," said Ricky Cassiday, owner of Data@Work, a real estate and market analysis firm in Honolulu. "That's not a bad thing, per se."

Cassiday also believes that Hawai'i's real estate market still has room to rise, but perhaps not at its previous breakneck pace. That's because Hawai'i's boom started about two years later than hot housing markets in areas such as San Francisco and Southern California. In addition, the state has robust employment and personal income growth — two key underpinnings of the housing market.

"I don't think we're overvalued," Cassiday said.

Historically, rates on 30-year fixed mortgages have to reach between 7 percent to 8 percent for the housing market to slow perceptibly, Brewbaker said. Mortgage rates probably will not reach that level until at least the end of 2005, he said. The average annual percentage rate for a 30-year mortgage in Hawai'i last week was 6.13 percent.

The stock and bond markets already are pricing in the expected rate increase.

Stocks generally don't react well to higher interest rates, because they slow economic activity. Higher rates also tend to hurt prices of existing bonds as they become less attractive to investors compared with new bond issues that pay higher interest.

"It will clearly be negative," said Harlan Cadinha Sr., chairman and chief executive of Cadinha & Co., a Honolulu investment firm that manages $700 million in assets.

Reach Deborah Adamson at dadamson@honoluluadvertiser.com or 525-8088.

• • •