Major Banks Expected to Lower Prime Rates in Wake of Economic Data

Economists predicted Friday that major banks will soon lower their prime lending rates--reversing a yearlong trend--in response to clear signs that the U.S. economy is slowing.

One medium-sized bank, Southwest Bank of St. Louis, lowered its prime rate Friday to 11% from 11.5%. None of the major money-center banks in New York immediately followed suit. But economists said national employment data released Friday, showing a much smaller than expected increase in non-farm employment in May, almost certainly will persuade the Federal Reserve Board in Washington to allow banks’ cost of funds to drift lower, possibly as soon as early next week.

Neal M. Soss, a managing director and chief economist at the First Boston investment firm, said such action by the Fed would prompt banks around the country to drop their prime rates to 11%. It would be the first drop in the prime since the Fed began nudging the rate up from 8.5% in May, 1988, to slow economic growth and quell renewed inflation. The rate has been at 11.5% since Feb. 23.

A Benchmark Rate

“If the Fed gives any kind of signal at all, as I would expect them to do, a prime rate cut would soon follow,” Soss said.

The prime rate charged by commercial banks is a benchmark used to set rates for many types of consumer and business loans, such as some adjustable-rate home mortgages and most home equity loans.

In recent weeks there have been several strong signs that the rate of economic growth is dropping. Auto sales and housing starts have been off. And inflation indicators, including employment figures and data on prices, suggest that renewed inflation is no longer an immediate threat.

Some interest rates paid by consumers have already started to fall. The Veterans Affairs Department in Washington, for example, said Friday that it would cut its maximum home loan interest rate to 10% from 10.5%. It would be the first change in the rate in more than six months.

“Inflation is under control,” said Robert Defina, a first vice president and senior economist at Security Pacific National Bank.

He noted that the rate of growth of gross national product appears to be below 2% annually, a level that should assure the Fed that its attempt to rein in the economy has succeeded and that it can ease off a bit. Defina said Friday’s Labor Department report on employment added further confirmation. “The whole report just exuded weakness in the economy.”

The report showed that non-farm employment rose by only 101,000 jobs in May, lower than the anticipated level of more than 200,000.

Banks raise and lower the prime rate so they can maintain a stable profit margin above their own cost of funds as measured by the federal funds rate, which is the rate charged on short-term loans between banks. The Fed, through various actions to control bank reserves, has kept the federal funds rate at between 9.75% and 9.875% since February.

The economists said the Fed might decide as early as Monday or Tuesday to allow the rate to decline to between 9.5% and 9.625%.

Many bankers had expected the Fed to act sooner. But members of the Fed’s policy-setting Open Market Committee reportedly were divided this week over whether to ease up now on interest rates or to maintain the pressure a little longer until economic data showed more conclusively that the threat of inflation had been vanquished.

Waiting for Signal

The Bush Administration has been putting pressure on the Fed to lower interest rates to halt the recent run-up of the dollar against major foreign currencies. The Administration fears that the strong dollar will hurt efforts to reduce the U.S. trade deficit.

Robert Dederick, chief economist for Northern Trust Co. in Chicago, said banks have been reluctant to lower the prime rate before receiving a clear signal from the Fed. He said banks do not want to be caught lowering their rates and then having to quickly raise them again if the Fed fails to lower their cost of funds.

Dederick said that although Friday’s employment figures were encouraging, the Fed may also want to look at the report on manufacturing activity due Monday from the National Assn. of Purchasing Management. He said the Fed may not act to lower rates if the report shows that the level of industrial activity is unexpectedly strong.

A drop in the prime rate would follow recent declines in some other interest rates. Three-month Treasury bills, for example, are at 8.35%, down three-quarters of one percentage point from their average rate in late March.