Bankers should brace themselves for a half-point rise in interest rates over the next few months, a veteran business observer warned Wednesday.
"Let's be cautious," urged Lyle E. Gramley, consulting economist to the Mortgage Bankers Association and a former member of the Federal Reserve Board. "Rates will have to move up a bit to slow the economy down to a safe and sustainable pace."
As he sees it, short-term rates will probably go up a quarter point by yearend and by another quarter point soon after at the behest of the Fed.
Mr. Gramley issued his prediction in New York at the MBA's annual convention. At the same time in Washington, Fed Chairman Alan Greenspan was strongly suggesting a very similar scenario.
Mr. Greenspan told the House Budget Committee he thinks labor costs, remarkably quiet this year, are bound to rise at some point. He said he believes that current labor trends suggest that the economy is on an unsustainable track.
In a jolt to investors, the Fed chairman also said it would be "unrealistic" to expect the stock market to keep gaining at the same rate it has been. That remark has sent stocks into a headlong retreat. (See story on page 1.)
Mr. Gramley's comments also packed a punch, jarring sanguine lenders at the conference. Housing and borrowing demands are close to all-time highs, and many lenders have confidently said they expect continued growth.
"I'm surprised" at the warning sounded by Mr. Gramley, said Michael D. McAuley, a regional director with Bank United, Houston. "I think there is cause for a bit more optimism right now."
But Mr. Gramley insisted the Fed will soon have to act to restore balance. "The economy is growing faster than its long-term growth potential implies" it can or should expand, he said.
He cited Japan, which at one point was looked to as a model economy, only to crumble in recent years because of lax economic policies.
By acting now, the Fed will help ensure the U.S. economy's longer-run health, said Mr. Gramley, who reassured his audience that "we'll still have a very good economy next year."
Inflation is expected to tick up modestly, to about 3% on an annual basis, and unemployment to drop some more before leveling out later in 1998.
He expects the pace of the rate hikes from the central bank to be staggered, which could soften the impact on financial markets.
"The Fed's job is very delicate," Mr. Gramley said. "They certainly don't want to precipitate a crash."
Indeed, he noted, much of the economy's buoyancy and consumer confidence is tied to wealth gained from the stock market's prolonged rally.
