Big Banks Drop Prime Lending Rate to 10% : Economy: Figure lowest since 1988. Adjustable-rate home loans to go down; other mortgages may be lower.

Major banks, foreseeing continued economic weakness, on Monday lowered their prime lending rates to 10% from 10.5%. The long-awaited reduction, the first drop in the prime since July 31, brought the key rate to its lowest level since October, 1988.

The drop in the prime--the benchmark on which some consumer and business loans are based--will directly result in lower rates on adjustable-rate home-equity loans and could be a harbinger of lower rates on home mortgages and other loans.

First National Bank of Chicago initiated this latest drop, and was quickly followed by Citibank, Morgan Guaranty, Bankers Trust, Security Pacific, First Interstate Bank of California, Bank of America, Wells Fargo Bank and other major banks.

As the Federal Reserve has eased interest rates in response to a slowing economy, the prime has fallen three times from its peak last spring of 11.5%. Many economists predict that the prime will fall at least one more time in the first half of this year, before starting to edge back up.

James Annable, chief economist at the First National Bank of Chicago, said his institution decided to make the move when “we sat down and looked at all the figures, and they indicated an economy that is continuing to weaken.”

During the past year, the falling prime has offered substantial relief to consumers, including those with the popular adjustable-rate home equity loans. About half of the $75 billion in outstanding home equity loans are tied to the prime and readjusted monthly.

Consider the case of a consumer with a $75,000, 10-year adjustable-rate home equity loan. If this borrower took out the loan in January, 1988, when the prime was 8.75%, he would have paid $939.95 a month, according to WEFA Group, an economic forecasting firm in Philadelphia.

At the prime’s peak last spring, his payment would have ballooned to $1,054.57. With this latest cut, the monthly payment would fall $63.34, or 6%, to $991.13.

The latest cut in the prime had been widely predicted for some time, and particularly since the third week in December, when the Fed allowed another key rate, the federal funds rate, to drop to 8.25%. The federal funds rate is what banks charge each other for overnight loans.

The difference between the banks’ cost of borrowing and the prime has been wide enough to warrant a drop in the prime for the past two months. The banks often cut the prime when this “spread” reaches 1.5 percentage points; since early November, it has intermittently exceeded 2 points.

But the banks held back, partly because of a slight end-of-year surge in loan demand, and partly because of a need to supplement profits in what has been a particularly tough year for many lenders, analysts say.

Indeed, in early November, Southwest Bank of St. Louis, often the first bank to drop the prime, lowered its rate to 10% from 10.5%. But other banks didn’t follow suit, and Southwest raised its prime again three weeks later.

Even with the last three cuts, the prime remains high by historical standards. Between 1948 and 1989, the prime has averaged 6.9%, according to WEFA Group.

Mortgage rates have also eased over the past year, and are expected to ease somewhat more in the first half of this year.

The effective rate on an average 30-year fixed-rate mortgage declined from 11% in the second quarter of 1989 to 10.1% in the fourth quarter, said James Christian, chief economist with the U.S. League of Savings Institutions in Washington. He predicts that the average 30-year fixed-rate mortgage will fall to 8.8% in the second quarter of this year.

One-year adjustable-rate mortgages fell from an average 9.7% rate in the second quarter of last year to 9.3% in the fourth quarter; Christian predicts they will ease to an average 8.8% in the second quarter of 1990.

Blue Chip Financial Forecasts, a newsletter in Alexandria, Va., found in a survey of 50 private-sector economists that a majority expected at least one more prime-rate cut in the first quarter of this year. It was the consensus of the group that the economy would strengthen, and rates resume their rise, in the second half.

While most economists believe the economy is weakening, the extent of that weakness is highly debatable, among very mixed signals. “There’s no overwhelming evidence that the economy is going up or down,” said Robert Dederick, economist with Northern Trust Co., in Chicago. “If anything, the signals are more mixed than they were six weeks ago.”