Prime Rate Cut; Key Index Falls : Leading Indicators Drop Again but Many Discount Fears of Recession

Major banks across the country cut their prime lending rates to 8.5% from 8.75% Tuesday amid growing concerns that the nation’s economy is on the verge of a recession.

Just before the banks acted, the government reported that its chief barometer of future economic activity fell for the third month in a row, a development that often signals a downturn just around the corner. And slack economic activity typically results in falling interest rates.

But, despite several recent negative economic indicators, a wide range of analysts say they are convinced that fears of a recession are overblown.

“If this is a recession we’re entering, it’s the strangest one we’ve ever had,” said Lyle Gramley, chief economist at the Mortgage Bankers Assn. and a former Federal Reserve Board member. “I see a brief slowdown in activity, but the engine driving the real economy has not been shut off.”

Other Rates Down

The drop in bank lending rates, which began with New York’s Morgan Guaranty Trust and quickly spread to most other major banks, occurred in response to recent drops in other interest rates caused by unexpected signs of economic weakness and speculation that the Federal Reserve might be forced to ease credit to help avert further erosion.

The cut in the prime rate--which is used by banks to set interest rates on a variety of business and consumer loans--leaves the key lending rate at its lowest level since last September, when it jumped to 8.75% from 8.25%. Banks last reduced the prime rate in early November, shortly after the Oct. 19 stock market crash.

Tuesday’s 0.2% drop in the Commerce Department’s index of leading indicators for December--following a sharp 1.2% November decline, which was primarily a result of fallout from the stock market collapse, and a revised 0.1% dip in October--was the latest in a series of reports that have convinced a number of analysts and many investors that the economy has already begun to turn downward.

“The question now is not whether we are in a recession,” said Irwin L. Kellner, chief economist of Manufacturers Hanover Bank in New York, “but how long and how deep it will be.”

Consumer Spending Falls

Last week, the government reported that consumer spending fell sharply during the last quarter of 1987, raising fears that a large accumulation of unsold goods may force companies to cut production and jobs to bring their inventories in line with shrinking sales.

The government reported also Tuesday that sales of new single-family homes fell in December for the second consecutive month, dropping 6.2% after a 2.4% decline in November.

In addition, jobless claims have been on the rise for the last several weeks, pointing to sluggish job growth last month and fostering worries inside the Reagan Administration that unemployment could start climbing this year. That would be a big blow to the Republicans’ chances of retaining control of the White House in November’s election.

If unemployment rose last month, as many analysts expect, it will become clear on Friday, when the Labor Department reports job figures for January.

In the reverse logic of Wall Street, though, bad news for the economy is usually good news for investors in the bond market, who welcome slow growth or even recession because it reduces the dangers of inflation and increases the likelihood that the Fed will try to stimulate the economy by driving interest rates down.

As a result, bond prices rallied throughout the day, and bond yields, which move in the opposite direction, sagged. The yield on the 30-year Treasury bond fell to about 8.32%, its lowest level since last April, from 8.42% on Monday.

But many economists remain unconvinced that the economy is collapsing. “The bond market is fundamentally misreading the economy,” Gramley said.

Mild Correction Seen

“The recession crowd is in full cry,” added Larry Kudlow, chief economist at the New York investment firm of Bear, Stearns & Co., “but I just don’t buy it. We are likely to see a mild mid-course correction that will extend the recovery, not abort it. Consumer spending has been sluggish, but, with low inflation, declining interest rates and lower taxes, all the fundamentals point toward a continued expansion.”

Analysts note that the leading indicators are not an infallible sign of an impending recession. The leading indicators have fallen for three months in a row 12 times since the index was created in 1948, but on four occasions no recession ensued.

The last time the index declined for three consecutive months was from June through August, 1984, when the economy slowed substantially from the earlier boom but continued to advance at a respectable pace.

Nor are there any indications of sharply higher interest rates and tighter Fed monetary policy, which have ushered in every significant recession since the end of World War II.

“Cosmetically, the numbers look bad, but if you examine the economy closely, all you see are pockets of weakness, mostly in the auto industry,” said Tim Howard, chief economist at the Federal National Mortgage Assn., the quasi-governmental agency that backs home mortgages. “People don’t realize that housing is not as weak as the recent statistics would suggest.”

Housing Slumped in ’87

Housing slumped at the end of 1987, but the weakness was concentrated in the Northeast, which has the highest home prices in the nation and appears to be bearing most of the brunt of Wall Street cutbacks stemming from the end of the bull market.

And early indications this year suggest that falling mortgage rates, which have recently dipped below 10% in many parts of the country, appear to be rapidly reviving demand for housing.

“We’re seeing a strong pickup in the demand for home loans,” said Jim Boyle, executive vice president and chief lending officer of Gibraltar Savings & Loan in Beverly Hills.

“This January was 10% to 15% better than last January,” Boyle said, “and it was getting stronger as the month went on. It looks like we’re going to have a carbon copy of 1987,” when housing sales boomed in the first few months of the year in response to similar declines in long-term interest rates.