Fed policy, slower growth combine to ease interest rates

By , Staff writer of The Christian Science Monitor

A cooling economy and a less restrictive monetary policy are two main reasons that interest rates, including the widely watched prime rate, are dropping. ''The Federal Reserve is moving to ease its posture'' on monetary policy, ''and that is tending to push down rates,'' says David Jones, chief economist at Aubrey G. Lanston & Co., a government-securities dealer. ''Second, the economy is weakening more than most forecasters had expected.''

The latest sign of slower economic growth came Tuesday, when the Federal Reserve reported that factory production fell 0.6 percent in September. The decline was attributed in part to a one-week strike at General Motors Corporation. September's decline was the first in industrial output since November 1982, the last month of the recession.

Slower economic growth and more accommodative monetary policy combined to cut what banks pay for the funds they lend to customers. As a result, this week a variety of major banks cut their prime, or benchmark, lending rates.

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On Monday, Bankers Trust Company of New York, the nation's ninth-largest bank , chopped its prime rate by half a point, to 121/4 percent. Led by Citibank of New York, the nation's second-largest bank, several other banks reduced their prime rates on Tuesday by one-quarter of a point, to 121/2 percent.

The prime is the rate banks often use to set interest charges for corporate customers. Often a bank's largest clients pay less than prime while smaller, less creditworthy customers pay more. General cuts in the prime rate last occurred in late September.

While the declining prime directly affects businesses, general credit conditions it reflects will affect individuals in a variety of ways, analysts say. Declining interest rates will tend to lower home mortgage rates. And that should help the housing industry, economists say. For instance, the interest borrowers pay on adjustable-rate loans often is tied to what the US Treasury pays to borrow money. At the Treasury-bill auction Monday, the yield to investors fell for the sixth consecutive week, to 9.98 percent, from 10.11 percent last week.

Of course, such lower rates will reduce the return to individuals who have invested in money-market mutual funds, notes Robert Gough, an economist with Data Resources Inc., a forecasting firm.

Rates on consumer loans usually decline more slowly than market interest rates, notes Harold Nathan, an economist at Wells Fargo Bank in San Francisco. But if market rates continue to move down, ''we should soon see some decline in (banks') consumer borrowing rates for automobiles and other durable goods,'' as well as in finance company loan rates.

''There has clearly been a slowing in the economy,'' says Bernard Markstein III of Chase Econometrics, another forecasting firm. But recent economic indicators ''are not saying the economy is going into a recession.'' For example , he notes, the government reported last Friday that retail sales rose a strong seasonally adjusted 1.6 percent in September, and stores are expecting strong Christmas sales.

Still, Fed chairman Paul A. Volcker ''has been encouraged by the inflation numbers of late and by the slowdown in the economy,'' suggests DRI economist Gough.

The latest inflation numbers came last week when the government reported September producer prices dropped by a seasonally adjusted 0.2 percent.

As a result of this and other upbeat news, Fed-watchers say, Mr. Volcker and his associates have adopted a less restrictive monetary policy. This has taken some of the starch out of interest rates. Since the Fed reports on its policy actions on a delayed basis, there is no way to know for sure if the Fed-watchers have correctly analyzed the Fed's intentions.

Economists try to determine the Fed's intentions by watching the federal funds rate. This is the rate banks charge each other for overnight loans taken out to maintain the level of of reserves needed to meet Fed requirements.

The Fed influences that rate by adding to or subtracting from the overall level of reserves in the banking system.

In mid-September, the federal funds rate was 11.5 percent, while at midday Tuesday it was 10.5 percent, according to Aubrey G. Lanston & Co.

The federal funds rate plays a major role in determining the cost of money that banks lend to customers. The falling cost of federal funds helped lead to the reduction in the prime rate.

Analysts say there are two reasons that some banks now offer a prime rate of 121/4 percent while others offer 121/2 percent. One reason is a difference of opinion about Fed policy and about the possible effect on interest rates of the Treasury's plan to sell $42.3 billion in securities in the next month.

At the same time, Mr. Jones says, banks with large foreign or domestic loan losses will ''drag their heels'' on cutting the prime in a bid to boost profits. Still, by year's end he expects a 12 percent prime to be widespread. Mr. Nathan, however, sees the prime beginning to climb again in the middle of 1985.

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