Bundesbank cuts rates as recession fears grow

Economy: As European interest rates fall, inflation worries temper hopes of further UK moves

Germany's Bundesbank cut its key interest rate by half a point to an all-time low of 2.5 per cent yesterday. The surprise move was a reaction to fears of recession in Europe's biggest economy.

Finance minister Theo Waigel said the fall in the cost of borrowing would help boost growth. But the economics ministry said it was doubtful whether the economy would achieve its 1.5 per cent growth forecast this year.

The feeble state of the German economy will be on the agenda at this weekend's meeting of the Group of Seven industrial countries in Washington. The Bundesbank's chief economist, Otmar Issing, said yesterday: "The economy is weak but this is not a recession. We still hope the second half of the year will be better."

The move came as a surprise because financial markets expected rapid growth in M3, the Bundesbank's monetary target, to delay a move. The statement with yesterday's reductions said: "Monetary trends are overstated by current figures."

In March M3 grew at an annualised rate of 12.2 per cent compared with the fourth quarter of 1995. This was slightly lower than February's 12.8 per cent but well above the 4 to 7 per cent target. However, Hans Tietmeyer, the Bundesbank president, said: "We see no direct inflation risk."

Julian Jessop, an economist at HSBC Markets, said: "The economy is clearly struggling and there is no inflation threat on the horizon. A half-point rate cut buys a little insurance against the risk that the expected economic recovery disappoints." Some economists suggested the Bundesbank might reduce rates even further if the economy remained weak later in the year.

Michel Camdessus, managing director of the International Monetary Fund, said the German move was "desirable". He said France should take advantage of the strength of its currency by following suit.

The Bundesbank's move was swiftly followed yesterday by rate reductions in Austria, Belgium, Denmark and the Netherlands. Austrian interest rates are at their lowest since the end of World War Two. Spanish and Italian central banks are expected to follow suit.

Germany's GDP fell by 0.4 per cent in the final quarter of last year, and could have shrunk by as much as 1 per cent during the first three months of this year.

The Bundesbank cut its discount rate, which sets a floor for other interest rates, by half a point to 2.5 per cent. It also cut half a point off the Lombard rate, taking it to 4.5 per cent. It fixed its repo rate, the key rate for money market intervention, at 3 per cent for two weeks.