Quarter-point prime rate increases to7-3/4 pct by Citibank and Chase Manhattan Bank today will be
followed by other banks only after they see clearer signs of
the Federal Reserve's policy intentions, economists said.
    "Based on the spread between banks' cost of funds and the
prime rate, it probably makes sense for others to follow, but
no rush is likely," said Paul McCulley of E.F. Hutton and Co.
    Citibank's surprise base rate increase, quickly followed by
Chase, sent U.S. bond prices lower and the dollar higher.
    McCulley said that once the spread between three-month
certificates of deposit and the prime rate narrows to less than
1-1/2 percentage points, there is a strong chance of a prime
rate increase. It has been under 1-1/4 points recently.
    However, banks are likely to hold rate increases until they
see what the Fed intends to do about interest rates in the near
term, analysts said. They noted that banks historically like to
follow Fed rate movements, rather than lead them. For example,
the last prime rate increase occurred in June 1984 when banks
lifted the rate to 13 pct from 12-1/2 pct after a Fed discount
rate increase in April of that year.
    Major banks had been posting a 7-1/2 pct prime rate since
last August 26/27, when they lowered the rate from eight pct
shortly after the Fed's half-point discount rate cut to the
current 5-1/2 pct level on August 20.
    "The banks will not rush to raise their prime rates. There
should be a split prime for a while with some posting a 7-1/2
pct rate and others 7-3/4 pct," said David Jones of Aubrey G.
Lanston and Co.
    Jones said the Federal Open Market Committee at today's
meeting voted no change in Fed policy. But he said the Fed may
well foster higher interest rates soon.
    Jones said that, while the FOMC probably voted no policy
change today, it may have decided to apply slight upward rate
pressure later if the dollar weakens, inflation pressures heat
up or the economy shows sign of strong recovery.
    "The Fed clearly indicated that they did not intend to
tighten policy when they did today's coupon pass," said Joseph
Liro of S.G. Warburg and Co.
    In a move that came a day earlier than most expected, the
Fed today supplied permanent reserves to the banking system by
offering to buy all maturities of Treasury notes and bonds for
its own account. This seasonal reserve add is called a "pass."
    "The Fed demonstrated that there has been no policy
change," said Elizabeth Reiners, economist at Dean Witter
Reynolds Inc. 
    She said the spread between banks' cost of funds and the
prime rate is now around 137 basis points compared with a 153
basis point average in 1986. Reiners said the spread is not
really narrow enough to present a clear need for a prime rate
increase.
    The Dean Witter economist said that today's prime rate rise
"may have been less a response to interest rates than an
attempt to enhance the (balance sheet) bottom line."
    Reiners said that, given recent problems with loans to
developing countries, large money center banks with heavy
exposures might be the first to match the higher prime rate in
an effort to get more profitable spreads on other loans.
    The Federal funds rate at which banks lend overnight money
to one another could help determine how many banks match the
higher prime rate and also how quickly they move.
    In raising their prime rates, banks cited a higher cost of
funds. In the three business days through Monday, the Federal
funds rate at which banks lend to one another averaged nearly
6-1/4 pct. But quarter end pressures helped push up funds.  
    The Fed funds rate was extremely volatile today, reflecting
demand pressure associated with the end of the quarter and the
close of the Japanese fiscal year. Funds traded between five
and 6-3/4 pct.
    Once the special distortions end, analysts said the funds
rate probably will return to its recent trading level in the
6-1/8 pct area. They said that, if it stabilizes near there,
banks may not quickly boost their prime rates.
    But a consistently higher funds rates would suggest to many
that the Fed was fostering somewhat higher interest rates to
help the dollar. Then banks would lift prime rates quickly.
 Reuter
