Fed rate cut sends prime to 4-year low Weak retail sales, modest inflation reported for Aug.


NEW YORK -- Reacting to bad news and good news about the economy, the Federal Reserve Board cut the discount rate, the most visible symbol of Fed policy, yesterday from 5.5 percent to 5 percent, its lowest level since 1973.

Shortly after the Fed's early-morning move, major banks, led by Morgan Guaranty Trust, followed suit, announcing reductions in their prime rate, the benchmark rate extended to premier customers, from 8.5 percent to 8 percent, the lowest level in four years. Morgan was quickly matched by First Interstate Bank of Los Angeles, Bankers Trust Co. of New York, Manufacturers Hanover and Citibank. Other banks were expected to act similarly.

In contrast to the broad rate reductions yesterday, banks maintained their rates in April when the Fed last cut the discount rate. That tended to improve the profitability of their lending operations, which had been badly hurt by defaults, but it did little to stimulate economic growth by lowering the cost of loans to customers.

"Before the Fed cut the discount rate, they made sure the banks would weigh in, too," said David Donabedian, an economist at Mercantile Bankshares in Baltimore. "I think at this point the Fed wanted to see consumer and business loan rates come down -- and they are."

The Fed's action comes after a series of consistent economic indicators suggested that prices for almost everything but medical services were increasing only modestly while sales for an equally broad range of products remained depressed.

"The last shred of evidence the Fed needed came in this morning with the announcement of consumer prices and retail sales," said Jay Woodworth, an economist at Bankers Trust.

Retail sales declined 0.7 percent in August, reflecting weak demand across the board with the exception of drugstore and gasoline sales. Meanwhile, the Consumer Price Index edged up 0.2 percent in August.

Lawrence Kudlow, economist at Bear Stearns, predicted that inflation for the full year might be below 3 percent for the first time since 1986 and only the second time in the past decade.

Still, the so-called core rate of inflation, which excludes food and energy, remained up 4.6 percent on an annual basis.

Opinions on whether the Fed's move will benefit the economy were mixed.

"These kinds of interest-rate declines will add up to enormous savings for homebuilders and others in terms of payments to the bank," said Mr. Woodworth. "This shifts the probability of economic recovery to a smoother, faster second gear."

"It's a long process," said Robert Chandross of Lloyds Bank. The Fed "has to continue to probe down to the point where it [the cuts] begins making a difference."

The financial markets reacted negatively yesterday, as stock and bond prices slid. The Dow Jones industrial average dropped 22.14 points to slip below 3,000, closing at 2,985.69. The price of long-term governments bonds dropped slightly.

Several economists suggested that enthusiasm for the interest-rate cuts had already been shown Thursday, when both markets moved up in anticipation of the Fed move.

"I think it's an example of the an old financial-markets adage: Buy the rumor, sell the news," said Mercantile's Mr. Donabedian. "This cut in the discount rate has been the most anticipated I can remember. Over the past several weeks, there has been a clamoring for it in both the bond and the stock market. Sometimes they get what they want and ask what is next."

Others, however, were more skeptical. "I think the fact the market sold off on this news tells us the real story," said James Dale Davidson, a Baltimore-based investment manager and financial newsletter writer who said he doubts whether the Fed's action can correct the broader problems dampening economic activity.

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