Bundesbank warns of German budget blowout

PAUL WALLACE

Economics Editor

The German Bundesbank has warned that the budget deficit in 1996 is likely to exceed the 3.5 per cent share of national output forecast by the government last month. Spending cuts were needed to bring the deficit in 1997 down to the 3 per cent qualifying limit for European Monetary Union.

In its latest report on the economy, the Bundesbank also put a further marker down for strict interpretation of the Maastricht Treaty by describing a deficit of 3.5 per cent as "well in excess" of the 3 per cent threshold. The gloomy projection, coming after Hans Tietmeyer, the central bank's president, recently used the "D" word - delay - is bound to heighten speculation about a possible postponement of EMU.

The Bundesbank dampened hopes of interest rates cuts by setting the repo rate - the rate at which it lends money to banks against collateral of securities - at 3.3. per cent for the next two weeks. In its monthly report it said that the recent half-percentage-point rise in German bond yields should be "ground for caution" about further cuts in money market rates.

This reinforced the view that any further cut in the discount rate, currently at 3 per cent, will be taken only when the Bundesbank is sure that this will be well received by the capital markets. The central bank said that "the current very low level" of bond yields, nearly 2 per cent below the average over the past 20 years, should support the recovery.

The German central bank said that the government's projections for the budget deficit in 1996 were based on assumptions of economic growth that were "too optimistic. "As a result the deficit was likely to increase as a share of GDP rather than stay at the 3.6 per cent reached in 1995."

A big factor behind the DM25bn deterioration in the deficit last year was the swing in social security funds from break-even to a shortfall of DM15bn. An increase of over 0.5 per cent of wages is already scheduled to tackle the problem, but the Bundesbank warned that further rises were necessary.

The Bundesbank said that far-reaching reforms to the German labour market and welfare system were necessary to make big inroads into unemployment, which it described as "Germany's most pressing economic problem". Lower wage increases and greater flexibility in such aspects as working hours were essential preconditions. The welfare system also needed to be reformed to create more incentives to seek work.

On a more optimistic note, the Bundesbank said that the drop in the West German inflation rate to 1.4 per cent - the lowest for more than seven years - showed that the goal of price stability had in effect been reached.