Bank Economists Anticipate Higher Rates by Next Year

After two years of rapid economic growth, a group of bank economists predict that the pace of growth will slow and long-term interest rates will begin to edge upward.

The American Bankers Association's economic advisory committee believes that the economy will expand at a 3.5% rate in real terms for the rest of this year, with growth slowing to "slightly more than 3%" in 2006.

"The economy has entered the 'Goldilocks zone' - not too hot and not too cold," said Richard DeKaser, chairman of the committee and chief economist at National City Corp., Cleveland.

The committee predicts that the underlying inflation rate will stabilize around 2% through next year. But the group also expressed concern that a tight labor market, rising employment costs, and persistently high oil prices could push inflation higher, sparking more aggressive action by the Fed to contain inflation.

The bank economists predict the Fed will continue raising the federal funds rate. They expect the fed funds rate, a determinant of short-term interest rates, to reach 4% to 4.25% by next spring. The group expects the yield on the 10-year Treasury note to rise to 5% by the end of next year.

The committee predicts the conventional mortgage rate will rise to 6.5% by the end of next year.

Mr. DeKaser said that the "conundrum" of persistently low long-term interest rates amid rising short-term rates is "anomalous and unlikely to persist."

That might have an impact on real estate appreciation.

"For the overwhelming majority of homeowners, their house is still a sound investment. But for those hoping to realize short-term speculative gains in frothy markets, we advise caution," Mr. DeKaser said.

The ABA's economic advisory committee meets twice a year in Washington to provide perspectives on the national and local economies. The group met with governors of the Federal Reserve Board, the chairman of the Council of Economic Advisors and the director of the Congressional Budget Office.

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