The Federal Reserve Board yesterday reduced the discount rate to its lowest level in two years, triggering an immediate response from major banks, which announced a cut in their prime lending rate by half a point to 14 1/2 percent.
The Fed action, its third such reduction in a month, lowered the discount rate to 10 1/2 percent from 11 percent. The discount rate is the interest the Federal Reserve charges member banks on the money it lends them.
Chase Manhattan, Manufacturers Hanover, Chemical Bank and Pittsburgh's Mellon Bank immediately announced they would reduce their prime lending rates to 14 1/2 percent Monday. Other major banks are expected to take similar action.
In cutting the discount rate, the Fed cited moderate growth in the money supply, reduced credit demand and declines in open-market interest rates as reasons. The Fed's action came amid evidence that the economy continues to be weak, with industrial production down by 0.1 percent last month, according to a separate report by the central bank.
Some financial analysts believe that the Federal Reserve is now trying to encourage a decline in interest rates in the face of the weakening economy while holding to its money supply targets.
Nicholas Marrone, vice president of the Bank of New York, said yesterday, however, that the Fed was merely validating lower market rates already in place.
Meanwhile, the Labor Department reported yesterday that producer prices rose 0.6 percent in July, fueled by the largest monthly increase in gasoline prices in eight years. But other components of the price index were generally lower, resuming the recent trend of declining wholesale prices.
The Federal Reserve, in reporting the nation's weekly money supply figures, showed that the key M1 measure, which includes currency and all checking accounts, stayed within the Fed's growth targets in the week ended Aug. 4, when it climbed $2 billion to a seasonally adjusted level of $453.4 billion. The Federal Reserve is thus able to ease credit conditions without threatening its monetary goals.
Lower interst rates are seen by many analysts as the key to economic recovery. Even with the recent rate declines, the cost of borrowing for many consumers and businesses remains extremely high. However, further declines in consumer loan interest rates are expected to follow a general easing in rates.
The Treasury already is benefiting from the interest rate decline. Three-month Treasury bill rates were trading at below 9 percent late yesterday, down from about 10 percent at the beginning of the week.
Economists said the July producer price index, though higher, was more in line with recent trends in consumer prices than the 1.0 percent increase in June. "I think we're in a transition to lower rates of inflation again," said Allen Sinai, an economist at Data Resources Inc., of Boston.
"We're back on track to what is probably a sustainable inflation rate for the rest of this year," said Sandra Shaber, of Chase Econometrics. Forecasters expect that wholesale prices will rise about 5 percent this year, and that consumer prices will show a 6 to 7 percent annual increase.
Analysts, pointing to the continued drop in industrial production, cautioned yesterday that the latest producer price index does not necessarily signal the early stages of economic recovery.
"The economy is not coming back, and that's what that number shows," Sinai said. "The economy really is bottoming out, and that bottoming out is taking a long time."
Before the figures were released, however, Treasury Secretary Donald T. Regan said it was "still possible" that the administration could meet its projections for economic growth for the third quarter of this year. "July was a disappointment, but we haven't seen the August figures," Regan said.
The producer price index for finished goods, which measures the costs of products at the wholesale level, rose at a 7.1 percent annual rate in July. The 0.6 percent overall index increase came on the heels of a 1.0 percent increase in June that followed four months of small declines or no change.
The report said that prices rose 3.6 percent at the wholesale level for the 12 months ended in July, and at 3.1 percent for the first seven months of this year.
The Labor Department said a sharp decrease in food prices offset the hefty rise in energy prices to moderate the July producer price increase. Food prices dropped 1.5 percent in July, the sharpest one-month decline in food costs since February, 1976. Had energy prices not been included in the producer price figures, the index would have fallen 0.2 percent in July, the department said.