Bank stocks led a broad market decline Friday despite news on producer prices that appeared to some observers to increase the likelihood of a cut in interest rates.

The S&P bank index was off 1.43%, compared with a 0.83% decline in the S&P 500 index, following a government report that the producer price index was unchanged in May.

Normally, banks could be expected to rally on this news, which was greeted as the latest confirmation that the Federal Reserve has succeeded in its campaign to prevent the economy from overheating and might now switch courses by lowering interest rates.

Now the only question for many economists is when and by how much the Fed will lower rates to stave off a recession. (See story on back page.) And the conventional wisdom is that lower rates are good for banks.

Investors, however, appeared more focused on the potential for higher loan losses if the economy is indeed weakening. And, given that the Fed was much more aggressive than expected in raising the federal funds target rate by 300 basis points since early 1994, there was considerable uncertainty about whether the news would be enough to spur it to change direction.

"There is total lack of confidence in the direction of rates; nobody knows," said Nancy Bush, a regional bank analyst at Brown Brothers Harriman & Co., New York.

Among the dramatic declines in trading Friday was a $1 drop in J.P. Morgan & Co. shares, to $70. Chase Manhattan Corp. stock fell 75 cents, to $45.25; Bankers Trust New York Corp. shares slipped $1.50, to $61.25; and First Chicago Corp. was off $1, to $56.125.

PNC Bank Corp. shares fell $1, to $26.125; First Fidelity Bancorp. dropped $1.50, to $49; and shares in MBNA Corp., the credit card specialist, fell $1.875, to $30.375.

Ms. Bush attributed the selloff in bank shares, which was in evidence all week, to a continuation of profit taking after a strong rally in the previous few weeks.

Charles Peabody, a UBS Securities analyst, said that although some consumer-oriented banks may suffer from credit quality problems, he is bullish about the prospects for banks over the next 12 months, especially those that specialize in corporate lending and trading.

Mr. Peabody said the money-center banks, which rely on purchased funds rather than consumer deposits, would benefit faster than other banks from a falling fed funds rate. He said trading results would continue to provide pleasant surprises and that fee income would continue to boost big corporate lenders.

Analysts at Alex. Brown & Sons, however, issued a report reassessing their stance on the industry. They lowered their ratings on Banc One Corp., First Bank System Inc., Republic New York Corp., and SunTrust Banks Inc. from "neutral" to "source of funds" - indicating a belief that bank stocks have "more merit as a defensive vehicle than as a sector that will produce sustained outperformance."

One reason for the change was the prospect of rising credit costs. "Considering where provisions are relative to a normal credit environment, " the analysts wrote in a notice to clients, "many banks' earnings are living on borrowed time."

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