The Federal Reserve's raising of interest rates on Tuesday, the strongest in its recent series of moves to thwart inflation, could squeeze banks' earnings over the long run, analysts said.
Some industry analysts viewed the Fed's move as a possible negative for banks, as stocks slipped on the news and longer-term bonds rallied.
By late in the day, major banks began responding with parallel increases in their prime rates, to 8.5% from 7.75%.
"We are seeing the flattening of the yield curve. That is not always a good situation for banks," said Nancy A. Bush of Brown Brothers, Harriman & Co., New York.
Rate increases had been widely expected by both the banking and Wall Street communities, but the 75-basis-point hikes in both the target federal funds rate and the discount rate were greater than anticipated.
The federal fund target now stands at 5.5%, and the discount rate at 4.75%. The increase in the latter, which the Fed charges on loans to member banks, was the largest since 1980.
Ms. Bush said: "I think we are now past the point of the banks holding off on deposit rate increases. The question is how they will be able to cope with this on the lending side."
The Fed's action came in conjunction with the regular meeting of the Federal Open Market Committee, which sets monetary policy. In a statement, the central bank said it moved to "keep inflation contained and thereby foster sustainable economic growth."
It was the sixth time this year the Fed has increased the funds rate and the third time it has raised the discount rate.
The target for fed funds, a key short-term rate, has been pushed up 250 basis points from the 3% level it occupied before the Fed's tightening campaign began last Feb. 4. The less-sensitive discount rate has been ratcheted up by 175 basis points from its February low of 3%.
Each previous time the Fed acted, bank stocks initially rallied after matching the central bank's fund rate moves with increases in their own prime lending rates.
The bank stock rallies this year eventually gave way to fresh investor concerns about the impact of future rate hikes on banks' earnings.
Many observers said the Fed is not done yet and may raise each of the rates it controls by yet another 50 basis points in December, although most economic indicators now signal a mild slackening of growth and minimal inflation.
"Growth is no more than moderate on balance. Inflation remains well contained, but with the economy now in full employment territory even a moderate expansion pace is too fast to prevent some steepening of the price-wage trend," said Robert G. Dederick, chief economist at Chicago's Northern Trust Co. "This is not a fate that either the nation's conservative central bankers or the world's unforgiving securities and foreign exchange markets considered acceptable."
The central bank began changing its accommodative credit stance last Feb. 4 when the funds target rate was pushed up 25 basis points to 3.25%. The target was raised another 50 basis points in two increments during the next 10 weeks, on March 22 and April 18.
On May 17 and again on Aug. 16, the Fed took even bolder action, raising both the funds rate and the discount rate by 50 basis points each. Minutes of the Aug. 16 session of the open market committee, which were subsequently made public, showed members voted 12-0 to raise short-term rates at that time.
The committee comprises Fed chairman Alan Greenspan and other Fed governors, along with the presidents of the Federal Reserve Bank of New York and selected other Fed district banks.
TUesday's meeting attracted a crowd of protesters outside the Fed's headquarters in Washington. About a hundred demonstrators representing community, labor, farm, and other groups carried signs with slogans like "Fed Up, Rates Down."