Interest rates fall across Europe

Germany throws lifeline to French franc as Bundesbank makes sharp cut in cost of borrowing

The Bundesbank yesterday gave a powerful boost to the German economy and threw a lifeline to the beleaguered French franc by slashing its main money market interest rate. The cut in the repo rate from 3.3 per cent to a historic low of 3 per cent was larger than expected and triggered rate reductions in Belgium, Austria and, to the surprise of the markets, France.

The French central bank cut its intervention rate from 3.55 per cent to 3.35 per cent. The markets in France had not expected a cut in rates, given the recent weakness of the franc, but welcomed the German cut, which takes some pressure off the French currency.

In the wake of the Bundesbank decision the mark weakened, while shares in Frankfurt surged ahead.As expected, the central bank held its official discount and Lombard rates, the floor and ceiling for money market rates, at 2.5 per cent and 4.5 per cent respectively. Pointing to weaker money supply figures, Hans Tietmeyer, the Bundesbank president, described the cut as "the continuation of our policy" that would "create clarity for the foreseeable future".

But German economists suggested the Bundesbank had now cut rates as far as it could. "This was no small step," commented Commerzbank's economist, Peter Pietsch. "The central bank has used up all its room for manoeuvre."

Pressure for a cut had come from exporters, still stifled by the high mark, and from politicians concerned by sluggish growth at home and turbulence on currency markets ahead of European Monetary Union in 1999. But the desire to help industry had to be weighed against the danger of fuelling inflation. M3 growth had slowed to 8.6 per cent last month, bringing the annual target of 7 per cent into view. Inflation, currently 1.6 per cent, rose slightly last month and is forecast to rise again this month.

Meanwhile, controversy has been raging about German economic growth, with anecdotal evidence suggesting that manufacturing has recovered from this year's mini-recession much more strongly than expected.

The IFO institute's business confidence survey released on Wednesday gave a surprisingly upbeat picture, showing a leap of nearly three points in its index within the past month, to the highest since last November.

The Bundesbank appears to have been unswayed by this bout of confidence, relying instead on hard statistics that offer merely a glimpse of the sought-after recovery. Even Germany's Economic Ministry, the lair of professional optimists, was restrained in its appraisal.

However, the recovery is being driven not so much by a surge in demand, but more by restocking. According to Commerzbank, stock reductions in the chemical industry and steel industry have come to an end.

The construction industry has come out of winter hibernation frozen, with no end to its slump in sight. Mechanical engineering is suffering from lack of investment, and is not expected to resume growth until next year. German consumers are still buying cars, but shunning other durables, and the market in home computers has virtually collapsed.

The cut in the repo rate is not expected to stimulate demand directly; its effect will be concentrated on the exchange rate. But by taking the pressure off the French franc, the Bundesbank has come to the rescue of EMU, signalling for the first time that it is prepared to look beyond domestic concerns and play a more active role on the European stage.

Comment, page 17