Chase Manhattan bank today lowered its prime lending rate from a record 20 percent to 19 and 3/4 percent, the first loosening of the high interest that has been squeezing the economy for a year.
The decline reflects a recent reduction of rates in the money market where interest charges are set by supply and demand. Because big banks, such as Chase, buy most of the funds they lend to customers in the money market, falling money rates are quickly reflected in the prime lending rate.
The prime rate is the interest a bank charges its best corporate customers for a short-term loan.
The cut in the prime by Chase, which so far has not been followed by other major banks, was greeted with euphoria in the nation's bond market.
"Right after Chase made its announcement, the market started to roar," said Edward T. Braniff, executive vice president of Drexel Burnahm Lambert, Inc. "Two or three institutions came in and vacuumed the street."
But because bond prices had been declining sharply until the last few weeks and because interest rates made the cost of carrying bonds oppressive, dealers did not have large amounts of bonds in their inventories.
"My impression is that the institutions (such as pension funds and insurance companies) got about 20 percent of what they wanted to buy," Braniff said.
Bond prices moved in the opposite direction from interst rates. On the average, bonds gained about $45 for each $1,000 a face value.
But the euphoria may be shortlived, many analysts caution.
"With markets as volatile as they are, the so-called peak in interest rates should not be defined as a particular figure but as a band, say from 18 to 20 percent," said Richard Everett, chief economist for Chase Manhattan. "The peak could last for quite a long time."
"It's the beginning of a very steep decline in short-term interest rates," said Lawrence Kudlow, chief economist for Bear Stearns, Inc. "But it's going to be three or four months before the decline picks up steam. Short-term rates are going to fall more slowly than people think during the next few months."
But the seeds of an interest rate decline are there, nearly all analysts believe. The economy appears headed into a recession, perhaps a strong one. Recession eventually lower demand for loans and also reduce the rate of inflation, the two major factors that push up interest rates.
In the stock market, elation over the cuts in the prime rate quickly turned to concern about the economy and the impact a recession will have on corporate earnings. The Dow Jones Industrial average of 30 stocks, after rising in early trading, ended the day down 12.11 points at 771.25.
"The economy was the primary worry today. The decline in interest rates was secondary," said Newton Zinder of E. F. Hutton & Co.
Chase, in making the announcement of a prime rate cut, pointed to the decline in costs the bank has faced in obtaining funds in recent days.
The federal fund rate, the interest banks charge each other for overnight loans of excess reserves, was 19 3/4 percent at the end of March. Tuesday, it was 18 1/4 percent.
More importantly, the big certificates of deposit banks issue to obtain funds, had declined from 18 percent on April 1 to 16 3/8 percent Tuesday.
Richard Peterson, chief economist for Continental Illinois National Bank, said the decline in market interest rates is due partially to expectations that inflation will wane in coming months and partly because high interest rates have caused "a slackening in demand" for funds.