The Federal Reserve Board yesterday lowered its discount rate to 6.5 percent from 7 percent, in a move expected to prompt further declines in interest rates throughout the industrial world.
It was the second time in less than two months that the Federal Reserve has lowered the interest rate it charges for loans to financial institutions and follows a dramatic fall in other commercial interest rates. At 6.5 percent, the discount rate is at its lowest level since May 1978. The new rate goes into effect on Monday.
The rate cut is expected to result in lower mortgage interest rates, as well as drops in some consumer rates in the United States. In many cases, these rates already are at their lowest level in nearly eight years.
The Federal Reserve action was decided in consultation with the Bank of Japan, sources said.
The Associated Press reported last night that Japan will lower its discount rate to 3.5 percent from 4.0 percent effective on Monday in an effort to slow the yen's rapid appreciation against the dollar.
The Fed expects other countries "to be more stimulative and cut their rates" in the near future, one source said.
The Fed considered that the dollar was weak relative to West German and Japanese currencies, and, in order to prevent the dollar's decline from snowballing, it "communicated" with other trading partners to cut their rates also, sources said.
"We expected them to move," a source said.
The dollar yesterday dropped to a post-World War II low against the yen -- to 174.13 yen to the dollar in New York -- and fell in relation to most other major currencies in anticipation of the Fed's action.
Although some market analysts expected the discount rate to be dropped to as low as 6 percent, one source said that would be inappropriate because the Fed did not want to signal it was easing monetary policy aggressively.
In a statement yesterday, the Fed yesterday termed its action a "technical change" that would place the discount rate in line with other market rates that have already fallen because of recent weak economic statistics, lower inflation expectations and anticipation of its action.
"The change in the discount rate also appears consistent with international interest rate considerations," the Fed said.
During the last rate cut on March 7, the Fed lowered the rate from 7.5 percent to 7 percent in an unprecedented coordination with the central bank of Japan, which reduced its rate from 4.5 percent to 4 percent just hours before the Fed acted. West Germany cut its discount rate several hours earlier.
That coordinated action was viewed as a joint effort by the major industrial nations to stimulate global economic growth, after they decided that the sharp drop in oil prices had averted fears of accelerated inflation for the foreseeable future.
Economic analysts yesterday predicted that major banks probably would lower their prime interest rate as early as Monday. The prime rate -- which serves as a base rate for many other loans -- is expected to decline from 9 percent to 8.5 percent.
Home mortgage loans, which already have dropped below 10 percent in most parts of the country, are expected to fall further, analysts said.
"We'll also probably see modest cuts in consumer loan rates and further drops in conventional loan rates," said William V. Sullivan, a senior vice president at Dean Witter Reynolds Inc. "Those rates had gotten sticky in the last few weeks. I do think this will be enough to prod 30-year conventional mortgage rates lower to 9.5 percent.
"Also, the key thing is, with the prime rate moving down to 8.5 percent, there are a lot of rates linked to the prime, like a majority of home equity mortgage rates" expected to fall to as much as 10 percent from about 11 percent, Sullivan said.
Fed Chairman Paul A. Volcker had earlier resisted an interest-rate cut because he said that lower interest rates could make U.S. assets less attractive, which would lead to a lower demand for the dollar and consequently a possible downward spiral in the dollar's value. If other major countries reduce their interest rates at about the same time, the dollar would not be disproportionately affected, analysts said.
In February, Volcker dissented in a vote to reduce the discount rate because he was concerned about the dollar. Federal Reserve Vice Chairman Preston Martin attempted to overrule Volcker on the vote, but the move failed when governor Wayne Angell changed his vote. Several days later, however, Volcker voted with the other Fed members to reduce the rate.
Martin resigned after the maneuvering.
In yesterday's vote, Volcker, Angell and governors Henry Wallich and Manuel Johnson voted in favor of the rate cut, and Gov. Emmett Rice voted against it. Martin and Gov. Martha Seger were absent, the Fed said.
Other analysts said that the Fed has been disappointed by recent economic statistics suggesting further sluggish economic growth. According to those statistics, production at the nation's factories, mines and utilities has declined for two consecutive months, and personal income has only increased slightly, which means consumers have less money to spend.
Additionally, the respectable 3.2 percent increase in the nation's output during the first quarter this week, masked weakness in many of the components of that important economic statistic, said Leonard Santow of Griggs and Santow financial consultants. He said that the increase in business inventories and animprovement in the trade picture helped the growth in Gross National Product improve.
Other factors in GNP, such as consumer, government and business spending, have been weak.
If the economy is sluggish, the Fed has more room to allow interest rates to fall without heating up the economy so much that it causes an acceleration in inflation.
In fact, inflation is probably the least of the Fed's problems right now.