Well folks, last week the Federal Reserve Board of Governors voted to cut short-term interest rates by one quarter percent to an astounding low level of one percent. Contrary to what a lot of folks think, the move did not spill over into the mortgage market. In fact, mortgage rates rose.

Let's go over the specifics:

The Federal Reserve has complete control over the Federal Funds Rate. This is the interest rate that commercial banks charge each other for short-term loans. The problem is that the Federal Funds Rate and thirty year fixed rate mortgages are not closely related.

The Fed's purpose in lowering the Federal Funds Rate is to stimulate borrowing and eventually stimulate economic growth. Since there are many other types of commercial and consumer loans that are tied to the Federal Funds Rate, the Fed's move is likely to lower borrowing costs on many other loans. Expect interest rates on personal loans, home equity lines and credit cards to drop a bit. Not necessarily true for long term mortgage rates.

As I said, the Fed's move created a spike in mortgage rates. Here's why in a nutshell. The Fed's decision to cut the Federal Funds Rate is a sign that it is taking proactive steps to create economic growth. This means higher stock prices, increased job hiring and all the other things that come with economic growth.

The downside to a robust economy is inflation - higher prices. And inflation results in higher fixed rate mortgages. This is what happened last week. Investors perceived the rate cut as a symbol that the economy will soon be picking up. When that happens, investors sell shares of "mortgage backed securities". A sell-off in mortgage-backed securities causes long-term mortgage rates to rise.

The bottom line is that no one really is able to predict the movement of mortgage rates because no one can predict when or by how much the economy will start to gain steam. When there are clear signs that the economy is recovering expect mortgage rates to rise.

Published: July 2, 2003

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, the president of PMC Mortgage Corporation in Alexandria, VA, is a mortgage columnist whose work has appeared in numerous consumer, real estate, and mortgage publications. Mr. Savage welcomes your questions for possible use in this column, however because of the volume of mail received, Mr. Savage cannot answer questions individually.