The closely-watched measure of the money supply known as M1 plunged $2 billion during the week ended Aug. 31, prompting interest rates to plummet in financial markets yesterday.
The drop in M1, which consists of cash, checking accounts and NOW accounts, buoyed the money markets which already were cheered by economic data showing improvement of the economy and decline of M1 during August, said William N. Griggs of Griggs & Santow Inc. The decline provided further evidence that inflation is under control and fueled speculation that in response, the Federal Reserve Board may ease it's monetary policy.
The prime rate, now at 11 percent, should drop to about 10.5 percent very quickly, particularly if rates for certificates of deposit decline, Griggs continued.
"We're going into this money number saying there are some fundamentals that seem to be going good for us," Griggs said. The market was anticipating about a $1 billion increase in M1. "This was a very good piece of news relative to peoples' expectations."
The latest drop in M1 means that the monetary aggregate grew at a rate of about 8.5 percent for the year through August, which is within the Federal Reserve Board's target of 5 percent to 9 percent growth. Griggs explained that combined with other good economic news such as lower inflation and a slowdown in the robust growth in the gross national product during the second quarter, this means there is less pressure for the Fed to restrict money growth, a step which would lead to higher interest rates.
Immediately after the money supply figures were announced yields on six-month Treasury bills plunged to 9.10 percent from 9.35 percent and the price of long-term bonds jumped $20 for each $1,000 in face value. Intermediate and longer-term rates generally are most sensitive to money supply results.
While the money supply figures and the bond market's response both auger for a lower prime rate, there is another incentive for a drop in the prime, Griggs said. In a speech on Thursday, Treasury Secretary Donald T. Regan blamed the financial industry for high interest rates and urged bankers to bring them down soon.