Commentary: German rates still crucial

In the brave new world outside the exchange rate mechanism, our Euro- sceptics and new enthusiasts for dirty floating would have us believe that we are able to disregard the level of the pound or the inconvenience of high German interest rates. However, there continue to be severe limits on our freedom of action, as the Governor of the Bank of England pointed out when he warned that we 'cannot afford to ignore the exchange rate'. The stock market agreed: yesterday it rose on hopes that German interest rates would come down.

Friday's Bundesbank council meeting in Schwerin is scarcely less important than it was when we were in the exchange rate mechanism. If German interest rates should fall by 1 percentage point or even more, the mark is likely to weaken against sterling. That in turn will make the Chancellor more relaxed about delivering another cut in British interest rates. With the pound down by more than 9 per cent compared with last year's average trade-weighted level, Mr Lamont can ill afford a further slide if he wants to cap inflation.

The latest report from the Ifo economics institute in Munich is so gloomy as to make a stark case for German easing. The growth of the M3 money supply is probably giving misleading signals, as it did in Britain in the early Eighties. High interest rates are attracting more interest-bearing deposits. Despite yesterday's rise in inflation to 3.6 per cent, the pressures are clearly downward.

The snag is that the Bundesbank yielded its last quarter-point cut only three weeks ago, and was roundly criticised for succumbing to political pressure. But the evidence of gathering recession is so strong that the Bundesbank should swallow its pride and cut again.