The Federal Reserve pumped additional cash into the nation's banking system yesterday to lower key short-term interest rates and offset a growing reluctance of banks to make loans.
On Thursday, Fed Chairman Alan Greenspan told the Senate Banking Committee that the central bank was considering such a step because the banks were pulling back and "in effect creating a tightening in credit markets."
With the outlook for growth already sluggish, Greenspan said such a tightening "could have undesirable effects on the economy." Lower interest rates could encourage more lending to creditworthy borrowers, even if many of those now being shut out by bankers still were unable to get loans.
Meanwhile, the government issued reports on retail sales and producer prices for June that analysts said were consistent with continued slow growth rather than an economic rebound or recession.
The Commerce Department said retail sales rebounded by 0.5 percent last month after three straight monthly declines that totaled about 2 percent. The Labor Department reported that producer prices for finished goods rose 0.2 percent last month as both food and energy prices went down.
Financial markets did not react to either report, but they paid close attention when the Fed intervened in the money market just before noon. Officials at the New York Federal Reserve Bank put out the word to government securities dealers that the central bank wanted to buy Treasury securities on a temporary basis. When the Fed buys securities, the dealers get cash that ends up deposited in the banking system.
Sam Kahan, chief economist of Fuji Securities in Chicago, said the Fed action, coupled with Greenspan's unusual statement the day before, was clear evidence that the Fed wanted to push down the federal funds rate -- the interest rate that banks charge on overnight loans to each other.
The federal funds rate, a key indicator of Fed policy, has been near 8.25 percent since just before Christmas when the central bank last eased a notch. Greenspan noted in his testimony Thursday that it is unusual for the rate to remain essentially unchanged for such a long time.
Kahan and most other analysts expect the federal funds rate, which quickly dipped to 8.125 percent, to settle at 8 percent.
When the federal funds rate changes, most other short-term rates change with it, especially those set daily by market forces as opposed to those set by financial institutions, such as the rates banks pay on certificates of deposit and their prime lending rate.
However, Kahan said the drop in the federal funds rate probably sets the stage for a decline in the 10 percent prime lending rate, although with banks not anxious to make new loans, there could be a substantial lag before competitive forces cause the prime rate to fall.
Many business loans and a growing share of consumer borrowing, such as home equity loans, are tied to the prime rate, which has been at its present level since January. The Fed obviously hopes that lower short-term rates will counter some of the negative economic effect from the banks' lending pullback.
The report on retail sales was seen by analysts as good news, but not necessarily a sign that faster economic growth lies ahead.
"It's a welcome sign for a beleaguered sector of the economy," said Allen Sinai, chief economist at the Boston Co., a financial advisory firm. "The question is whether it's a one-time reversal of a string of weaknesses or the start of something new."
Underscoring the recent weak pattern for consumer spending, economist David Wyss of DRI-McGraw Hill, an economic consulting firm, noted that retail sales are "up only 2.4 percent from a year ago. That's not even keeping up with inflation."
Producer prices rose 0.2 percent last month, slightly less than in May, even though prices for food and energy products ready for sale to consumers both fell slightly. Prices of other finished goods rose 0.6 percent, the largest monthly increase in a year.
The Labor Department report said higher prices for tobacco products and new cars -- which rose because of the end of some rebates -- were major contributors to the increase.