Prospect of lower rates ignites the markets

DIANE COYLE

Economics Correspondent

Hopes that a round of international interest rate cuts will start in Germany tomorrow, ahead of a weekend meeting of ministers from the Group of Seven leading industrial countries, ignited financial markets yesterday.

The prospect of lower rates, triggered by a looming economic crisis in Germany, took the mark lower against the dollar and other currencies. The dollar touched DM1.46 before falling back slightly. German share prices set a record.

The pound also strengthened against the mark. Shares in London jumped, the FT -SE 100 index ending nearly 48 points higher at 3,710.6. Paris and other Continental stock markets also climbed, but Wall Street was down 21 points to 5,027 at midday.

Richard Kersley, equity strategist at BZW, said: "A mood of optimism about lower interest rates has revived."

Fears about the danger of recession mean interest rates in the US, Britain and the rest of Europe are widely expected to fall within the next few weeks.

Most City of London economists believe Kenneth Clarke, Chancellor of the Exchequer, and Eddie George, Governor of the Bank of England, will probably not move after their meeting today, but a quarter point base rate reduction is likely in February or March.

The fact that Michael Heseltine, Deputy Prime Minister, let slip a day early news that unemployment had fallen for the 28th month in succession in December, did nothing to dent the view that the economy's weakness justifies lower rates.

Evidence that the German economy is slowing sharply has raised expectations that the Bundesbank will trim its repo rate, a market rate at which it deals with banks, after its council meeting tomorrow.

Hans Tietmeyer, president of the Bundesbank, fuelled the sense of anticipation in financial markets when he told German television that interest rate could fall if growth of the M3 money supply measure remained below target. Analysts think the official discount rate is likely to be reduced before the end of March. The Bank of France is also expected to act tomorrow.

The G7 finance ministers and central bankers meeting in Paris at the weekend will discuss the danger of a global slowdown. French Prime Minister, Alain Juppe, said French and German economics ministers would meet separately to discuss the economic troubles afflicting both countries.

The G7 meeting is one of a clutch of international policy sessions, starting with yesterday's monthly meeting of central bankers at the European Monetary Institute in Frankfurt, and leading on to an EU finance ministers' meeting on Monday.

Gerard Lyons, chief economist at DKB Securities in London, said: "How to transform the dead-weight of the German slowdown back into the engine of European growth will be at the top of the G7 agenda."

Recent evidence indicating that Germany's GDP was, at best, flat in the final quarter of last year after falling in the third quarter has caused consternation among policymakers, not least because it suggested the country will find it difficult to satisfy the Maastricht criteria for joining the European single currency. In 1995 the German government budget deficit was 3.6 per cent of GDP, above the 3 per cent target.