Banks Cut Prime Rate to Eight-Year Low of 8% : Act on Fed’s Cue to Reduce Interest Costs
Acting on cue from the Federal Reserve Board, the nation’s leading banks Friday lowered their prime lending rate by a half point to 8%, the lowest level in eight years.
The Fed signaled its intention to move interest rates broadly lower on Thursday, when it reduced its discount rate to 6% from 6.5%, the central bank’s third such move this year. The discount rate is what the Fed charges commercial banks for short-term loans and is a key instrument of economic policy.
Cuts by California Banks
Banks across the country quickly acted on the Fed signal, beginning with New York’s Chemical Bank, the nation’s sixth largest. Every other major U.S. bank followed, including all the leading California banks, pushing the prime rate to its lowest level since May, 1978. At the beginning of this year, the rate was 9.5%. The banks last cut their prime rate on April 21, to 8.5% from 9%.
The prime, or reference, rate is the benchmark that banks use to set borrowing costs for business customers. The best corporate borrowers pay the prime rate or a little less, and firms considered more risky pay a premium above prime.
Consumer rates, although not tied directly to the prime, tend to move in the same direction, but more slowly. Mortgage, auto and personal loan rates have been falling this year, and bankers said they expect them to continue to edge down.
Jim Stecker, president of Spindle Co. in Glendale, which manufactures specialty plastics items, welcomed the drop in the prime rate, which directly affects his cost of doing business and his sales prospects.
“It affects the overhead appreciably,” Stecker said. “It’s even more important to a small company like ours because, when the rate comes down, people start spending. When the prime rate goes up, everybody gets scared, puts plans on hold and it impacts our sales enormously.”
Federal Reserve officials are encouraging lower interest rates to give a boost to a lackluster economy, but economists debated whether their efforts would be effective.
Rate Could Be Lower
“Too little, too late,” said private economist A. Gary Shilling in New York. “We estimate that, if the Fed were neutral (neither trying to stimulate nor cool the economy), we’d be looking at a discount rate of 3% to 3.5% in this period of no inflation and sloppy growth. If they were aggressively easing credit, it would be lower than that.”
Shilling estimated that inflation this year would be no more than 1.5%, meaning that interest rates are still high in relation to the cost of other goods and services. He noted that the last time prices for such key commodities as food and oil were steady or falling was the late 1950s, when the bank prime interest rate hovered between 3% and 4%.
Kathleen Cooper, chief economist for Security Pacific National Bank in Los Angeles, said she thinks the Fed action will have the intended effect of boosting production and consumer spending.
“Our anticipation is that the economy will pick up,” she said. But, if it does not, she said, the Fed will be forced into another round of interest rate-cutting.
Tax Bill Breeds Caution
Analysts agreed that key sectors of the economy remain weak and may not respond quickly to tinkering with interest rates. Manufacturing, agriculture and capital spending are all depressed, in part because export sales have been poor. Uncertainty about the effects of the tax revision bill now before Congress also has led to caution among business executives about spending plans.
“The short-run impact (of the tax bill) is decidedly negative,” said Mickey D. Levy, senior vice president and chief economist at Fidelity Bank in Philadelphia. “The Fed will find it has to lower rates more, and substantially more,” to have the intended effect on spending and production.
