The Federal Reserve Board, seriously concerned about the continuing recession and new strains in financial markets, yesterday seized an opportunity and lowered from 12 to 11 1/2 percent the interest rate it charges on loans to financial institutions.
The Fed's move to lower the so-called discount rate was seen by financial market analysts as signaling an effort to promote a general easing of interest rates. Other relatively aggressive steps in recent weeks by the Fed have provided more cash to the banking system and laid the groundwork for lower interest rates.
Analysts noted the central bank was free to act without jeopardizing its longer term anti-inflation goals because slower growth recently of various money-supply measures has put them back within the Fed's targeted range.
In addition, some volatile, short-term interest rates have dropped as much as 3 percentage points since the end of June, giving the Fed the opportunity to lower the one rate it controls directly--the discount rate.
Before the Federal Reserve Board change was announced late yesterday, Manufacturers Hanover Trust Co. and First National Bank of Chicago, the fourth and eighth largest commercial banks, respectively, in the United States lowered their prime lending rates from 16 1/2 to 16 percent.
Several smaller banks also reduced rates to 16 percent, and other banks were expected to follow.
Interest rates on short-term Treasury securities also fell yesterday at the regular weekly auction. The rate on three-month Treasury bills dropped from 11.797 percent last week to 11.14 percent, the lowest since Dec. 21.
The Federal Reserve has been under increasing pressure from some members of Congress to lower interest rates in order to spark a recovery from the worst economic slump since the 1930s.
Some Reagan administration officials also have urged the Fed to try to lower rates while insisting that it also stick to its announced intention of gradually lowering money growth to fight inflation.
Federal Reserve Chairman Paul A. Volcker will appear before the Senate Banking Committee this morning to disclose the Fed's money growth targets for the remainder of this year and those tentatively chosen for 1983.
Volcker is expected to urge Congress to continue to try to reduce prospective federal budget deficits for the next several years as one way to help bring down interest rates.
But most Fed-watchers believe it was neither pressure from Congress nor the administration that has caused the Fed to loosen its tight grip on credit in the past month. Instead, two other developments are paramount, in their opinion:
First, the economy gives no indication a recovery is on the way, and most economists blame the high level of interest rates for that. After some better news in May, there was a renewal of the slump in June, according to most statistics now available.
The Commerce Department added to the list yesterday by reporting that housing starts dropped 15.3 percent last month to a seasonally adjusted annual rate of 911,000 units. Earlier, it was reported that employment and industrial production also fell in June.
Second, the collapse of the Penn Square National Bank of Oklahoma City in which many large uninsured depositors stand to lose millions of dollars and other banks, which had participated in loans originating with Penn Square likely will lose even more, has sent tremors through the entire banking system. The best way to calm those fears would be to encourage lower interest rates, analysts said.
"It's clear the economy, in the eyes of the Fed, is in difficult straits," said economist Allen Sinai of Data Resources Inc., an economic consulting firm. "They don't want to make it too difficult to have a recovery, and at this point there are no signs of a recovery at all."
With the drop in the discount rate, and the other previous steps providing more liquidity to the banking system, the Fed "probably has gone as far as they will for now," Sinai said. However, this should be enough to lower short-term rates another one-half percentage point or more, he predicted.
But the economic payoff will not be immediate even if rates stay down. "Lowering the discount rate is an important step that signals their intentions," Sinai added, "but it can't do the economy much good before the fourth quarter and perhaps late in the fourth quarter. This quarter is already lost."
Moreover, some analysts expect interest rates to rise again soon as the Treasury seeks to borrow a record $50 billion or more this quarter to finance the current budget deficit.
The discount rate had been 12 percent since Dec. 4, when it was cut from 13 percent. The prime lending rate at most large commercial banks had been 16 1/2 percent since early March.
In May, Citibank, the largest in the country in assets, briefly dropped its rate to 16 percent but no other banks followed and Citibank went back to 16 1/2 percent.
William Sullivan, vice president of the Bank of New York, said that in the past three weeks the interest rates paid on 30-day certificates of deposit, a major source of lendable funds at many big banks, had tumbled from more than 15 percent to 13.3 percent.
The spread between the CD rate and the prime is large enough that further declines in the prime are likely.