Continental Illinois National Bank, Chicago's largest, today cut its prime lending rate from 19 percent to 18 percent, and many of the nation's banks quickly followed.

Separately, the Commerce Department reported an extremely slim increase in estimated retail sales nationwide during September. This came as a surprise to some analysts who had expected a decline.

Retail sales volume was projected at $88.4 billion for the month, up just 0.44 percent from August and 10.2 percent higher than September 1980. But the government also revised upward to 1.3 percent the increase in sales for August--twice the rate of gain estimated earlier.

The unexpected retail sales strength forced bond prices to their lowest levels of the day in late trading, with some bond dealers worried that the economy may be stronger than has been forecast and that interest rates could remain high as a result.

The prime, an interest rate on which banks base most of their charges for short-term business loans, has declined from 20 1/2 percent in the last month, although not as fast as some other key short-term interest rates.

Roger Anderson, chairman of Continental Illinois, said that the prime rate has not fallen as fast as other interest rates because bankers are uncertain about the general economy and about money and credit conditions.

"It now appears that the lower levels of the short-term rates will continue long enough to indicate a lowering of a full 1 percentage point in the base rate at this time," Anderson said.

As the prime rate fell in the United States, several important European interest rates also were lowered. The Bank of France, that nation's equivalent of the Federal Reserve, cut its discount rate from 19 1/2 percent to 18 1/2 percent. The discount rate is the interest the Bank of France charges member banks who borrow funds for seven days.

In Germany, the Bundesbank announced that it was trimming the yields on a wide array of government securities.

Meanwhile, a top Democratic economist said today that President Reagan's planned $1.6 trillion military buildup is likely to drive up weaponry costs due to bottlenecks caused by the program's rapid pace. Charles L. Schultze, who headed the Council of Economic Advisers under President Carter, told a congressional joint economic subcommittee that cancellation of part of the recently enacted income tax cuts may be necessary to cope with projected cost overruns and to avoid increasing the budget deficit.

But "given substantial excess industrial capacity, a relatively plentiful material supply and today's 7 1/2 percent unemployment level, the bottleneck problem in the defense industries probably will not add to cost pressures in the private economy in a major way," he added.

The weak retail sales report today appeared to back up private economists' estimates that the nation is in the midst of a sluggish period that may presage recession.

The Commerce Department said auto sales rose last month--when manufacturers were offering rebates--while sales declined at food, clothing and department stores.

Although Chicago's Continental was the first to drop its prime rate to 18 percent, Chase Manhattan Bank, New York's second largest, reduced its main business lending rate to 18 1/2 percent last week. Except for Crocker National Bank of California, which lowered its prime to 18 1/2 percent Monday, no other major bank followed Chase's lead. Instead, big banks such as Bank of America, Citibank, Morgan Guaranty, Chemical, First Chicago and Marine Midland waited until today to cut a full point off their prime rates.

Manufacturers Hanover Trust Chairman John McGillicuddy said tonight he expects short-term rates to fall over the next 14 months, with the prime reaching 12 percent to 13 percent by the end of 1982.

The prime rate is the interest rate banks charge their best corporate customers for loans from three months to a year. But some big businesses pay less than the prime rate for some loans, while big businesses that are less creditworthy and smaller businesses often pay more than the prime lending rate.

Because of controversy over the prime rate, many banks have changed its name. Continental, for example, calls it the "base" rate.

In recent weeks, short-term interest rates have fallen, in large measure because the Federal Reserve, the nation's central bank, seems to have loosened its monetary policy, but also because a slowdown in business activity has reduced demand for credit.

White House spokesman David Gergen said today that, while the U.S. economy is "sluggish," it is not in a recession and will rebound in 1982. Monday, Albert T. Sommers, the chief economist for the business research foundation, the Conference Board, said the U.S. economy is in a recession. Sommers said that the recession, caused in large part by high interest rates, probably started in August. Unemployment in the United States jumped from 7.2 percent to 7 1/2 percent between early August and early September.

If the economy is in a recession, interest rates are likely to decline further. The federal funds rate, the interest banks charge each other for overnight loans of excess reserves, has declined from the 18 1/2- to 19-percent range several weeks ago, to the 14- to 15-percent range in recent days.