The surprising strength of the nation's economy prompts many economists to expect higher interest rates a year from now, according to the latest American Banker Yield and Rate Survey.
Short-term rates may be a quarter to a half percentage point higher by the third quarter of 1997, but some longer-term rates may actually be lower because inflation will be modest, in the consensus view of the 10 forecasters surveyed at major regional banks and Wall Street securities firms.
"We are going to have a resilient economy, with a little more inflation," said Dana Johnson, economist at First Chicago Capital Markets, a unit of First Chicago NBD Corp.
Mr. Johnson, who has the highest rate forecast in the latest survey, foresees a federal funds rate of 6.5% next year, up from 5.25% now, and a 9.5% bank prime lending rate, compared with 8.25% now.
He explained that he does not expect the Federal Reserve to be aggressive enough in raising rates this year. As a result, further measures will be needed in 1997 to moderate economic growth.
The Chicago economist sees things as akin to 1994. That February, the Fed began pushing up rates to brake the economy and tightened more than expected in a bid to thwart incipient inflation.
In a year's time, the Fed's target for the federal funds rate doubled, to 6% from 3%. The funds rate is what banks charge each other for overnight loans of reserves.
Mr. Johnson thinks the Fed will start a new round of credit tightening Tuesday, moving up one-quarter percentage point, or 25 basis points, and a similar amount in November or December. "They will assume this is enough to rebalance the inflation risks," he said, "but my bet is they will need to do more."
The reason more will be required, he said, is that the U.S. economy has become less rate sensitive. "We are seeing some of that now in the resilience of housing starts" despite higher market rates since last spring. Housing activity in 1994 did not begin dropping until nearly a year after the Fed began tightening, Mr. Johnson noted.
Also expecting higher rates to be imposed starting Tuesday is Nicholas S. Perna, chief economist at Fleet Financial Group Inc. He said he thinks the funds rate will be 5.75% and the prime rate 8.75%, each half a point higher than today, by this time next year.
"Recent wage increases and the tight labor market suggest potential inflationary pressures building," he said. "The Fed would much rather prevent inflation than respond after the fact."
On the other hand, some watchers foresee lower rates, including G. David Orr, chief capital markets economist at First Union Corp. He predicted a 4.75% funds rate and 7.75% prime rate by a year from now, half-point declines.
"Our view is that the Fed should not, and will not, raise short-term interest rates," Mr. Orr wrote in a recent report. Underlying inflation indicators mentioned by Fed Chairman Alan Greenspan "look very different than in 1994," he said.