Prime Cut

Economic theory says that in sluggish times lower interest rates will help spur production and growth. Theoretically, then, economists should have applauded loudly last week when major U.S. banks cut the prime lending rate that they charge many business clients from 8% to 7.5%, the lowest level since 1977. Instead of hoorays, though, the news was met with skepticism. The reason: many economists now doubt that further cuts in interest rates will give much of a boost to the economy, which was muddling along at only a .6% annual clip in the second quarter. Another sign of the economy's mixed prospects came with the release of the latest index of leading economic indicators, the government's chief forecasting gauge. The index rose by a sharp 1.1% in July, but that gain was balanced by a revision of June figures that showed a decline of .4% rather than the previously reported increase of .3%.

The banking system itself seemed to be reticent about the latest rate cut. It came well after the Federal Reserve Board on Aug. 20 lowered the discount rate it charges member banks from 6% to 5.5%. Normally, major banks lower the prime within 24 hours or so after such a move. This time, five days elapsed before San Francisco-based Wells Fargo became the first institution to react, though competitors thereafter quickly fell in line. Industry experts suggest that one reason for the sluggishness was that many major banks, facing massive liabilities in Latin America and elsewhere, are trying to boost revenues. By stalling on rate cuts, the banks can profit on the difference between what they pay for funds and what they charge their customers. Says Steven Gavios, a New York City banking analyst: "The major banks were trying to hold on to expanded profit margins as long as possible."

The main beneficiaries of the interest cut will be medium- and small-size businesses that typically borrow at or near the prime rate. (The nation's largest corporations are usually offered rates below prime to prevent them from turning to alternative financing sources, such as bonds and overseas capital markets.) The drop in the prime will also have an effect on consumer loans. Rates for 30-year fixed-rate home mortgages, for example, have already dropped below 10% in the Northeast for the first time since April. On the other hand, yields on passbook savings accounts, which have traditionally hovered at around 5%, fell to 4.75% last week at several major institutions. Many bank-credit-card rates remain stubbornly high, at between 17% and 20%, except in Arkansas and Connecticut, which have laws limiting rates on plastic.

Many experts predict that the Federal Reserve will soon lower its rates yet again, perhaps within the next six weeks. It remains to be seen, though, whether cheaper financing alone can prod along a significant economic expansion.