Banks began cutting their prime rates on Thursday after the Federal Reserve cut interest rates for the first time in nearly three years.
Banc One Corp. and BankAmerica Corp. were among the first banks to move, trimming their prime rates to 8.75% from 9%. Others were expected to follow suit.
Seeking to prevent the recent weakness in the nation's economy from turning into a recession, the central bank cut its target rate for overnight loans of bank reserves, the federal funds rate, by a quarter point to 5.75% from 6%.
"Inflationary pressures have eased enough to allow a modest adjustment in monetary conditions," the Fed said in a statement after the midyear meeting of its open market committee, which sets rates.
Although the rate cut could trim asset yields for banks, investors in bank stocks were heartened by the idea that a business downturn may be averted.
Bank stocks rallied on the news, with 40 of the top 50 banks gaining ground.
A revitalized economy would improve business for banks, said Thomas H. Hanley, banking industry analyst at CS First Boston Corp. "I remain very positive on banking stocks over the balance of this year."
Economists said the cut amounted to an important change of thinking for the Fed.
"There is no inflation fight at the moment. The priorities are shifting," said Robert G. Dederick, economic consultant to Chicago's Northern Trust Co.
The economist said it suspected the quarter-point move was "a compromise move between two camps" within the Fed's policymaking community. "Those who wanted 50 basis points and those who wanted none."
The move was mostly symbolic, in the Fed's classic manner, noted Mr. Dederick. "They showed concern, but also demonstrated caution," he said.
Not everyone saw the shift as positive. "This is definitely bad for bank earnings," said Richard X. Bove, analyst at Raymond James & Associates, St. Petersburg, Fla. He said that banks' spread of asset yields over funding costs are sure to narrow.
The policy change comes nearly a year and a half after the Fed started a credit tightening campaign that ultimately may have slowed growth in the economy further and faster than the central bank had intended.
The Fed began by pushing up its desired federal funds rate 25 basis points, to 3.25%, on Feb. 4, 1994.
By last Feb. 1, when the central bank last raised rates, the yearlong campaign of credit tightening had doubled the federal funds rates to 6% from 3% and lifted the discount rate by 275 basis points to 5.25% from 3%.
The discount rate was not cut on Thursday. It remains at 5.25%.