The commercial bank prime lending rate, which stood at 13 percent from July until early this month, will drop to 12 percent on Monday, a number of major banks announced yesterday. Some financial analysts expect a further drop in the rate, perhaps next week.
Most of the cuts were from 12 1/2 percent, though a few banks, including Bankers Trust Co. of New York, already were at 12 1/4 percent.
Short-term money market interest rates have fallen sharply since early last month, with some rates down about 1 1/2 percentage points. The decline has lowered the banks' cost of obtaining lendable funds and paved the way for reductions in the prime rate.
Some analysts said banks generally have sought to keep the prime -- to which about half of all commercial and industrial floating rate loans are tied -- up to bolster their profits. However, competitive pressures have forced the banks to drop the rate.
But the cost of obtaining funds, such as through the issuance of large certificates of deposit, has continued to drop, too. Yesterday, three-month CDs were yielding less than 10 percent, a figure that would more normally be consistent with a prime rate of about 11 1/2 percent rather than 12 percent.
Short-term interest rates have been declining both because of a sharp slowing of the rate of economic growth and because the Federal Reserve eased its monetary policy stance somewhat last month. The Fed may have taken another step toward easing within the past two weeks or so, but top analysts said it is too early to be sure.
"It's beginning to look like they have taken another bite, but I'm not positive," said an economist with a major New York bond dealer.
The level of the federal funds rate -- the interest rate banks charge when they lend reserves to each other -- is one guide to Fed policy, though it can be a misleading indicator at times. The federal funds rate averaged around 11 1/2 percent in August and much of September before the Fed eased. Yesterday the rate stood at about 9 1/2 percent for much of the day.
Until last week, analysts generally thought the Federal Reserve was aiming at a funds rate of between 10 percent and 10 1/2 percent. Now they think the range is probably lower, perhaps as low as 9 1/2 percent but more likely closer to 10 percent.
"We could easily have a funds rate of 9 1/2 percent or 9 3/4 percent," said economist Charles Lieberman of Shearson Lehman/American Express. "It is quite possible that the Fed has eased another notch."
The Fed does not, as it once did, closely peg the federal funds rate by varying the level of reserves available to the banking system. Instead, it lets the market set the rate and move it up and down so long as other Fed goals for the availability of reserves, money supply growth and economic growth are being met. The decline in the prime, and the similar response of other short-term interest rates, is the result of both an easing of Federal Reserve pressure on bank reserves and an easing of the demand for funds as a result of the slower pace of the economic expansion, analysts said.
The decline in short-term rates has been mirrored in the home mortgage market. The average commitment rate nationally for 30-year fixed-rate loans, after hitting nearly 14 3/4 percent at the end of July, has fallen to 14.1 percent last week, according to a survey by the Federal Home Loan Mortgage Corp.
Likewise, adjustable-rate mortgages, commonly available at initial rates of less than 10 percent last spring, have fallen back to the 11 to 11 1/2 percent range in many areas after topping 12 percent in midsummer.
Meanwhile yesterday, long-term bond yields, which also have dropped substantially in recent weeks, rose for the second day in a row. Bond dealers said the strong customer demand for bonds that characterized the recent rally had dwindled. "The customers have just stopped buying right now," said one dealer.
The uncertainty about how the Federal Reserve will respond to the slowdown in economic growth was another factor cited in the failure of long-term interest rates to continue their decline. "We may be at a point at which the Fed isn't really sure what it wants," quipped one analyst.
A number of analysts and forecasters believe that the end-of-summer drop in rates will turn out to be no more than a brief respite. Once economic activity resumes growing more strongly, as they expect, rates will rise again, the analysts predict.
But for the moment, there are few signs of such a pickup. As Townsend-Greenspan & Co., an economic consulting firm, told its clients a few days ago, "It is not surprising . . . if the Fed has decided to ease a bit further. Some of the conditions which appear to have impelled the last move to ease are still present, and do not appear to have improved.
"The dollar is still so strong that central banks are again intervening to try to restrain its rise. In addition, there reportedly is great concern within the Fed about the condition of many financial institutions . . .
"Since economic activity has slowed, inflation rates are still low, and money supply is growing sluggishly . . . , there is nothing to prevent the Fed from easing further," Townsend-Greenspan said.