WHILE THE BANKS have reduced their prime lending rate, they haven't reduced it much. As a response to the general decline in interest rates, including the rates at which banks borrow, the quarter-point reduction in the prime rate belongs to the minimalist school of expression.
Rates have been drifting downward in reaction to the accumulating evidence that the economy is slowing down. They are now back in the range where they stood in the late spring and early summer of last year, when the banks' prime rate was 8.25 percent a year. But the bankers have now reduced the prime only to 8.5 percent. The reasons have less to do with profiteering than with prudence. The banks evidently fear that interest may shortly start to creep back up, and they are leaving themselves a little turnaround space.
The rates at which banks borrow are set in the constant auction of the markets, and the trends are recorded in obscure tables in newspapers' financial pages. But changes in the prime rate, while less important, are declarations of policy and enjoy great prominence. In this election year, increases in the prime can be expected to bring heavy growls from Washington. And it's not just the election. Congress is currently working on legislation that would make fundamental changes in banking regulation. The bankers seems to have concluded that it's a time for discreet and noninflammatory conduct.
But if the economy is slowing down, why would interest rates rise? The answer lies in the international flows of money, a subject that New York follows more closely than Washington. Enormous amounts of foreign money have poured into the American financial markets over the past six years. To keep that money here requires interest rates that are higher than those available to investors in Japan or Europe. The recent decline here narrows the differentials between American and foreign rates.
If foreign money begins to pull out, the result will be a capital shortage and higher interest rates regardless of the administration's wishes or the Federal Reserve Board's decisions. With all that in mind, the bankers are trying to be cooperative -- but, at the same time, they have good reason to be cautious.