Major U.S. Banks Cut Prime Lending Rate to 8 1/2%

The nation’s leading banks, acting on cue from the Federal Reserve Board, on Monday reduced their prime lending rate to 8 1/2% from 9%.

Economists said the interest rate cut should help spur growth, drive consumer loan rates lower and reduce Third World borrowing costs. Several observers cautioned, however, that interest rates are unlikely to fall much further before inching back up later this year.

The banks’ move followed the Fed’s reduction in the discount rate last Friday to 6.5% from 7%, its lowest level since May, 1978. The discount rate is the rate that the central bank charges financial institutions for short-term loans.

The Fed said it took the action in response to pressure in financial markets, where interest rates have been moving steadily lower for several months. A discount rate cut is widely read as a signal that the Fed wants all interest rates to fall as an incentive for increased spending and investment.

The banks quickly complied with their second prime rate reduction in six weeks, led by Chase Manhattan Bank, the nation’s third-largest bank. All other major U.S. banks followed by midday. The prime rate was last at 8 1/2% in June, 1978.

The prime rate is the benchmark interest rate that banks use to set borrowing costs for their corporate customers. Also known as the base or reference rate, it is the rate that banks generally charge their most creditworthy customers, while other borrowers may pay 1 or more percentage points above prime. It has no direct relation to rates that consumers pay for mortgages, auto loans and credit cards, but a falling prime usually means that these loan rates are headed downward as well.

“All rates are dropping, and I think they will continue to come down,” said Leonard Weil, president of Mitsui Manufacturers Bank in Los Angeles. “I don’t think they’ve bottomed out.”

Weil noted that mortgage rates have been declining in anticipation of commercial lending rates, the reverse of the normal pattern. Usually, consumer interest rates fall after business lending costs are cut.

Rates for 15-year fixed-rate mortgages last week averaged 9.84% around the country, a full point lower than at the first of the year. Interest rates paid to depositors also have been falling.

Economists disagreed on whether interest rates would decline further this year. Lacy Hunt, chief economist at the Wall Street investment firm Carroll McEntee & McGinley, said he believes that rates might fall slightly but would head upward soon.

“I think the decline in rates is playing out. That doesn’t mean they’re going to go up right away, nor does it mean that we won’t have some further market action tending to push the rates further lower. . . . But the second half (of the year) will see a trend toward irregularly higher rates. The trend will be up.”

But Harold C. Nathan, chief economist at Wells Fargo Bank, predicted a new round of interest rate cuts this summer. “There’s a relatively good chance that short-term interest rates could move another notch lower. That would be precipitated by another cut in the discount rate, to 6%, perhaps by late summer. The two most important factors are lack of inflation and the lack of strong economic growth.”

Lower interest rates and falling oil prices should provide a stimulus for increased consumer and business spending, Nathan said. But the generally rosy economic picture could be adversely affected by the continuing downward movement of the dollar, he warned. If it falls much further in relation to other currencies, particularly the Japanese yen, U.S. authorities may be forced to intervene and drive interest rates back up, Nathan said.

Falling U.S. rates are good news for troubled Third World borrowers, whose loans are pegged to international bank lending rates. For example, this year’s decline of 1 percentage point in the prime rate will lower Mexico’s borrowing costs by $750 million, according to Kathleen Cooper, chief economist at Security Pacific National Bank.