NEW YORK -- Against a backdrop of a suspect recovery, the Federal Reserve Board drove a key interest rate down yesterday to levels not witnessed since the mid-1960s.
The reduction in the federal funds rate, used for loans between banks, to 3.75 percent from 4 percent was endorsed by the financial markets: Stock and bond prices rallied.
The Dow Jones industrial average, down nearly 100 points earlier this week, bounced back with a 43.61 rise yesterday, closing at 3,224.96. Yields on the bellwether 30-year Treasury bond fell to 7.86 percent from 7.91 as prices rose about one-half percent.
The Fed cut came as government statistics and corporate reports suggested weakness in retail sales and money supply growth, among other key gauges.
"The economy hit an air pocket in March," said Jay Woodworth, senior economist at Bankers Trust, and the Fed's action "just improves the odds for a recovery."
The rate cut was slight, but several analysts said it might be a preliminary step for a more decisive move.
"If this is all they will give us, they might not have bothered at all," said Edward Yardeni, chief economist at C. J. Lawrence.
The quarter-point drop might be too narrow to permit another round of prime rate reductions by major banks. It should, however, swell the margin between their cost of funds and their lending rates, further bolstering the beleaguered industry's recovering profitability and lay the groundwork for future cuts to be passed along, Mr. Yardeni said.
News of the Fed's action came about 11:30 a.m. and appeared to be orchestrated for wide publicity.
Although the news had an electric affect on securities prices, activity on the New York Stock Exchange remained restrained. Still, trading was relatively heavy.
Unlike the discount rate, which is set by the Fed, the federal funds rate moves according to the amount of reserves available in the banking system. By adding to the supply, the Fed can lower its target for the rate -- though banks are free to charge higher or lower rates, depending on market forces.
There was little consensus among market observers about the rationale for the cut.
Still, the timing was auspicious. Earlier this week, concern mounted that the crash in the Japanese markets would cause a crisis here.
Major department store chains indicated yesterday that the rebound in sales evident in January and February had waned. And money supply numbers released yesterday showed that growth had begun to slow, as it did in 1991.
Over the past two years, the Fed has responded belatedly to such evidence. "It turned out to be a good warning signal for how the economy did, and the Fed is trying to avoid making the same mistake twice," said Allen Sinai, chief economist at the Boston Co.