Prime rate trends over the past decade

By Ben Woolsey

The prime lending rate, often simply known as prime or prime rate, is the index that most lenders use to price their loans to consumers. Banks and credit card issuers typically use this rate as a way of protecting their bottom line against the ever-fluctuating cost of accessing funds in the capital markets. These lenders generally add an incremental percentage, or "margin," to their rates to generate a profit since the prime rate is usually what they must pay to get the funds.

Since 1996, the overall level of the prime rate is down. However, the rate was fairly stable until January of 2001. In an effort to jump start tepid U.S. economic growth and to head of deflation, then Fed Chairman Alan Greenspan led a fiscal policy involving an unprecedented series of rate cuts over a period of 28 months. During this period the prime rate fell 550 basis points, from 9.5 percent to 4 percent, a rate which had not been seen since April of 1959!

The prime rate stayed at this remarkably low level for a full year, until June of 2004. Since that time the Fed has taken the opposite fiscal approach by steadily increasing rates to their current level of 7.5 percent. Newly minted Fed Chief Ben Bernanke has stated he intends to stay the course in terms of keeping the brakes on the U.S. economy and possible inflationary pressures caused by low cost funds.

Going forward in 2006, the prime rate is projected to keep increasing. Another 25 basis point hike is predicted sometime before the summer months, according to leading economists on Wall Street. But only the movement of leading economic indicators, such as housing starts, employment levels and growth in the money supply is expected to provide the nudge required for the next increase.

Published: May 2, 2006

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