Bank stocks advanced Thursday as interest rates fell and financial markets rallied on a surprising economic report that temporarily calmed inflation fears.

The producer price index for September declined by an unexpected 0.5%, the government reported, momentarily easing pressure on the Federal Reserve Board to raise rates again.

Both stocks and bonds opened up sharply on the news, then settled back to await farther data on business conditions.

A better picture of the inflation outlook will be available today as the government releases its latest data on the consumer price index, retail sales, and capacity utilization in the manufacturing sector.

Meanwhile, Wall Street analysts and economists were cautiously optimistic that better times are ahead for the bank stocks, which nose-dived in recent months on fears of rising rates.

"The inflation fears are temporarily on the back burner now, although that's something that could change as early as Friday of course," said Frank J. Barkocy of Advest Inc.

"The bank stocks have had a rough time of it, and we are in a catch-up period, helped by the fact that they are posting some decent numbers for the third quarter," he said.

Noteworthy gainers in Thursday's market included First Interstate Bancorp, up $1.375 to $79.875; Bank of Boston Corp., up 62.5 cents to $27.375; First Fidelity Bancorp., up $1.125 to $42.625; and First Union Corp., up 75 cents to $43.25.

Shares of Wells Fargo & Co. pushed back above the $150 level, before closing down 25 cents to $149.375. Signet Banking Corp. gained 75 cents to $35.

"As long as the market doesn't collapse again on the basis of inflation considerations, we could continue to see a rebound in some of these stocks,"

But Mr. Barkocy cautioned that the markets, which sold off sharply in September on rate worries, "could overreact as much on the basis of positive expectations as they did on the negative side earlier."

Other analysts attributed much of the bank stocks' recovery this week to rising bond prices.

"With the strong bond market over the past few days we are finally getting a bounce in the bank stocks," said Lawrence W. Cohn of PaineWebber Inc.

"They certainly deserve it after the beating they've taken," he added. "September was grim."

"We'll just have to wait and see how long it carries through. If the Fed doesn't have to do anything for a while, that widens the window of opportunity for these stocks to do well."

"An eruption was overdue" in the bank group, agreed George M. Salem of Prudential Securities. He said the bond rally was probably the primary cause for banks' gains, rather than earnings.

"A good CPI number and an end to interest rate nervousness could keep this thing going," he said.

But the analyst added that a correction was to be expected after the bank sector's poor showing during the summer.

Fears that the Fed would raise rates again either this month or no later than Nov. 15 at the next meeting of the Federal Open Market Committee meeting persuaded many investors to shift from banks to cyclical stocks.

And signs of a healthy economy, like improved employment and increased capacity utilization, convinced many investors and economists that a Fed rate hike was all but certain.

The latest producer price figures raise at least the possibility that the Fed will not act until early next year, though economists generally believe a November rate hike is likely.

"Banks will do very well, and could even outperform the market" through the end of the year, said Edward Yardeni, senior economist at C.J. Lawrence, a division of Deutsche Bank.

Mr. Yardeni predicted the Dow Jones industrial average could top 4,000 by the end of the year. But a lot will depend on today's CPI number, said Jeffrey K. Thredgold, senior business economist at Keycorp.

"If the number today is anything but ugly, then the Fed has the luxury of waiting until November" to raise interest rates, he said.

He said there is a now just a 75% chance the Fed will hike rates next month, as opposed to a 100% certainty before Thursday's news.

Others still see a rate hike before Thanksgiving. Ken Ackbarali, senior economist with First Interstate, said he was certain the Fed would raise interest rates next month by at least 25 basis points.

If the CPI number is higher than expected or other signals of inflation emerge, the Fed may choose to ignore the PPI and hike rates, he said.

But at least for the next four weeks, banks have a grace period.

Sung Won Sohn, senior economist with Norwest Corp., said that banks have not actually been hurt by rising rates this year, but .conceded that market psychology is such that rising interest rates hurt bank stocks.

So with interest rates at bay, bank stocks, particularly money-center shares, are primed for improvement, Mr. Yardeni said.

Money-center banks, which finance themselves with purchased funds at market rates more than regional banks, could be the biggest beneficiaries.

If banks stocks rally, then U.S. bank merger and acquisition activity could accelerate, said Mr. Sohn.

"With interstate banking a reality, more and more stock-related merger activities will take place," he said. "And with the better outlook for interest rates, activity may get started sooner than expected."

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