Bank stocks weakened again Friday as prospects for another increase in interest rates continued to grow.

Investors worry that another rate hike by the Federal Reserve could not be passed on by banks as easily as in May, when the prime lending rate was quickly increased in response to a Fed credit tightening.

"If we do see another rate increase, I think it is likely to be far less beneficial to the fundamentals of banks than were the prior increases," said Frank J. Barkocy of Advest Inc.

Bank Index Lags Dow

Reflecting this nervousness, bank stocks underperformed other shares last week. The American Banker index of 225 bank stocks gained 0.66% versus a 0.94% gain for the Dow Jones industrial average in the five trading days ended Thursday.

It was a continuation of banks' dispirited July performance. During that month, the bank index edged up 1.25%, while blue chips improved 2.66%.

Friday's slippage came in tandem with another selloff in the bond market after the Department of Labor's monthly employment survey for July turned out to be stronger than expected.

The government said nonfarm payrolls had grown by 259,000 during the month, greater than the 215,000 increase that economists had forecast. June's huge increase was revised downward by 23,000 jobs, to a gain of 356,000.

The U.S. civilian unemployment rate rose 0.1%, to 6.1% of the work force in July, from 6% in June, the report said.

"Each day, we get a reaction to one small piece of the total picture," said Advest's Mr. Barkocy. "The markets are very unsettled and tend to overreact to both good and bad news."

"There is a lack of conviction in the markets," agreed Nancy A. Bush of Brown Brothers, Harriman & Co. "There is some of the same feeling around as in the summer in 1990," of both political and economic uncertainty.

Iraq's invasion of Kuwait occurred in August 1990, leading to the Gulf War.

Big Merger in Offing?.

As for banks, Ms. Bush said that investors may feel the sector is overdue for a major event such as a blockbuster merger that would generate strong ripples across the industry.

"We've gone without anything like that for some time now," she said, "and history shows that isn't going to continue indefinitely."

Rumors continued swirling that Fleet Financial Group, Providence, R.I., would join with another large institution in a merger of equals akin to the merger of Keycorp and Society Corp.

Bank of New York Co. is sometimes mentioned as a likely partner for Fleet. Both companies have routinely declined to comment on their plans.

Waiting on the Fed

Fleet's shares were off $1.125, to $36, in late trading Friday. Bank of New York was off 12.5 cents, to $31.875.

The market's nervousness is likely to continue until the Fed either raises rates again or firmly abstains from doing so, perhaps at the Aug. 16 meeting in Washington of its policymaking open market committee.

"The difference this time around," Mr. Barkocy said, "is that the benefits banks have enjoyed by raising the prime aggressively and doing so little on [the] deposit side may be hard to duplicate."

"Acting as they did before," he said, "opened up the margins, but given the pricing competition out there may not let that happen again."

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