The Federal Reserve lowered short-term interest rates Tuesday for the third time in less than two months, sparking both a round of prime rate cuts and a rally in bank stocks.
The Fed cut its target rate for federal funds by a quarter percentage point, to 4.75%. The funds rate is the overnight loan rate among commercial banks and serves as the starting point for other rates.
Bank of America, Chase Manhattan Bank, and Bank One announced within an hour after the Fed's move that they would lower their prime rates by a quarter point, to 7.75%, effective Wednesday. Other banks followed.
Bank stocks surged ahead on the rate news, far outpacing the general market. The Standard & Poor's bank index advanced 1.97% Tuesday, compared with a 0.3% gain in the broad market S&P 500.
The performance reflected a long-held belief among investors that lower rates protect banks' credit quality and thus earnings. Analysts said that means bank results may compare favorably with nonfinancial companies next year.
Besides the federal funds rate, the Fed cut the discount rate, its own lending rate for banks, by a quarter point, to 4.5%-the second such move this fall.
In taking their latest action, Fed chairman Alan Greenspan and other central bank monetary policy officials appeared to look beyond the dramatic rebound in stock prices triggered by earlier rate cuts, on Sept. 29 and Oct. 15.
Instead, they focused on abnormal spreads persisting in some sectors of the credit markets and on recent significant data about business conditions in the "real economy"-notably, moribund inflation and slackening job growth.
In a brief statement, the Fed said it moved Tuesday because "unusual strains remain" in the financial markets. And it noted that its three recent cuts in the funds rate, totaling three quarters of a percentage point, should help foster "sustained economic growth."
"I think there are enough signs of genuine weakness in the U.S. economy to justify this, and the deleveraging that occurred as spreads widened argued for pushing some more liquidity into the system," said William Cheney, chief economist at John Hancock Mutual Life Insurance Co., Boston.
In one of those signs, the Bureau of Labor reported earlier Tuesday that consumer prices rose a slight 0.2% in October and were up just 1.5% from a year ago. Meanwhile, some wholesale and commodity prices are declining.
"There is a whiff of U.S. deflation," said Philip Braverman, chief economist at DKB Securities USA, New York. While October finished goods wholesale prices edged up 0.2%, prices at early and middle stages of production-the so-called pipeline prices-were lower.
The falling wholesale price level implies narrower margins and falling corporate profits ahead, according to Sung Won Sohn, chief economist at Wells Fargo & Co.
At the same time the manufacturing sector is stagnating. The industrial capacity utilization rate, believed to rank among Mr. Greenspan's favorite indicators, dropped to 79.4% in October, the lowest level in more than six years.
And job growth has recently begun to slow rapidly. "Labor markets in the U.S. are showing unmistakable signs of a serious slump," said L. Douglas Lee, an economist in Washington for HSBC Securities.
Average growth in monthly employment slipped from 265,000 payrolls per month over the past year to 205,000 over the past six months to 198,000 over the past three months to 136,000 over the past two months to just 116,000 last month, he noted.
Among bank stocks, New York's Citigroup rose $1.25, to $45.625; Bank One $1.125, to $53.375; and BankAmerica $1, to $60.75.
The smaller Nasdaq-traded banks fared even better, improving 2.08% overall. At the same time, the much-watched Dow Jones industrial average slipped 0.28%.