Seeking to enliven a slack economy, the Federal Reserve cut interest rates again on Wednesday. Banks quickly began responding with reductions in their prime lending rate.
In line with its gradualist approach of the past few years, the Fed sliced the federal funds rate by a modest 25 basis points to 5.25% and also cut the discount rate, its own lending rate to banks, by a similar amount to 5%.
Within several hours of the Fed action, First Chicago NBD Corp., Banc One Corp., and Chase Manhattan Corp. were among the first major banking companies to reduce the prime rate, to 8.25% from 8.5%.
Wall Street analysts view lower rates as a mixed blessing for banks. If the Fed can prolong the economic expansion, banks' loan demand and credit quality are helped, but at the same time yields on banks' assets fall and their net interest margins are squeezed.
"These rate cuts are creating a significant margin problem for the vast majority of banks in the United States," said bank analyst Richard X. Bove of Raymond James & Associates, St. Petersburg, Fla.
Bank stocks rallied on the news, with many investors apparently trading on the conventional wisdom that lower rates benefit financial stocks.
It was the second decrease in as many months for the funds rate, the overnight rate for interbank loans, but the first for the discount rate since the Fed shifted away from its tight credit stance last summer.
In a statement explaining its action, the central bank said: "Moderating economic expansion in recent months has reduced potential inflationary pressures going forward. With price and cost trends already subdued, a slight easing of monetary policy is consistent with contained inflation and sustainable growth."
The Fed's move had been increasingly expected over the past few days by the stock and bond markets after arrival of fresh data - some from the Fed itself - revealing weak business conditions.
Over the same time, more Wall Street and banking industry economists have been warning of the potential for a serious slowdown or raised their odds of a possible recession later this year.
"The Fed knows that inflation is contained. They are aiming their efforts at containing the slowdown, and they are sending out a bit stronger signal than they have recently," said Robert G. Dederick, economic consultant to Chicago Northern Trust Co.
Earlier this week, the Commerce Department reported that retail sales during December, the important Christmas selling season, inched up only by a faint three tenths of a percent.
And in a sign that retail activity may stay weak, the Conference Board, a private business group, said its index of consumer confidence slumped by 12 points in January.
Last week, the Fed reported that industrial production at the country's factories, mines, and utilities gained a tepid one tenth of a percent in December. For the year, manufacturing output was ahead by 3.2%, down from 5.9% in 1994.
In line with those figures, the central bank said industrial capacity utilization fell to 82.8% in December from 83% a month earlier and to the lowest level since January 1994.
Meanwhile, the Commerce Department said sales of new homes fell to a seven-month low in November. Existing-home sales also fell and single- family housing starts by builders were flat.
Some observers also have speculated that the Fed's action on Wednesday was an effort to avoid falling behind the pace of the economy - as the central bank's own account shows it did five years ago.
In October 1990, newly released Fed minutes disclose, Mr. Greenspan talked other members of the Federal Open Market Committee out of lowering rates.
"At the moment, it isn't raining outside," he said. "The economy has not yet slipped into a recession."
Subsequent data, however, established that a recession had indeed begun three months earlier. It was also a deeper contraction than was known at the time.
The Fed's action came almost exactly a year after its last rate hike. Last Feb. 1, the funds rate peaked at 6%, after a half-point increase from the Fed, and the prime rate was raised by most banks to 9%.
After a slowing of the economy at midyear, the Fed sliced the funds rate by 25 basis points to 5.75% on July 6 and reduce it by a similar margin on Dec. 19.
Given recent data, the Fed also may simply not have wanted to wait until the next scheduled meeting of its monetary policymakers on March 26.
