Bank stocks rallied Wednesday after fresh evidence of low inflation led to renewed speculation that the Federal Reserve may not raise interest rates next week.

Near the close, the Standard & Poor's bank index was up 7.88 points, or 1.53%, while the broad-market S&P 500 index rose 2.92 points, or 0.35%.

Shares of Citicorp, the nation's largest capitalization banking stock, were up $2.50 in late trading to $120.25.

The latest spur for the stocks was the release of April data for the producer price index, which revealed deflation at the wholesale level. The PPI for April fell an unexpected 0.6%, and is up a mere 0.8% over the past year.

"The Fed faces a difficult choice," according to Bruce Steinberg, chief economist at Merrill Lynch & Co. "We believe they want to tighten (credit) once more to make sure that demand remains moderate going forward. But recent economic reports make it hard to justify an immediate tightening. It's now a very close call."

The Fed's policymaking open market committee, which raised short-term rates a notch on March 25, meets Tuesday in Washington.

But despite the uncertainty over rates, Wall Street analysts remain mostly optimistic about banks. "All the fundamental factors are still quite positive for the banks," said Francis X. Suozzo of Alliance Capital Management.

"There is still significant operating leverage and significant financial leverage through buybacks, plus the successor acquirer banks are really bringing down the overall cost structure of the industry," he said.

"I'm sleeping very well these days recommending these stocks," said Anthony J. Polini of Advest Inc. "On average, we expect about 20% upside from the banks this year," he said.

"That's less than 50% in 1995 and 30% to 35% 1996, but historically very good," he noted. "The challenge right now is to get people to lower their expectations a bit."

Shares of high loan-to-value lender Mego Mortgage Corp., Atlanta, hit a 52-week low of $8 Wednesday on very heavy trading.

Volume for the day totaled nearly 2.9 million shares, compared with average daily volume of 19,000. The shares ended the day down $1.625, or 16.3%, at $8.375.

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