Rate cut blow hits markets

THE BUNDESBANK yesterday triggered a steep fall in European bond markets by leaving key interest rates unchanged and undermining hopes for an early cut in rates across Europe, including Britain.

The Bundesbank decision came after a suprising rise in German broad money supply, M3, in December. The M3 measure shot up by an annualised 8.1 per cent, swollen by a massive DM60bn inflow of funds from abroad that exceeded the tide unleashed by the ERM upheaval of September 1992.

German bond futures dropped by half a point, helping to drive down gilt-edged prices. The March long gilt future slumped by a full point and the FT-SE 100 index dropped by 28.8 points to a closing 3,491.5, t hopes dimmed.

Markets were further rattled by rumours of an early rise in US rates in the US Treasury market. Alan Greenspan, the Federal Reserve chairman, warned earlier this week that US real rates were now 'abnormally low' and the Fed's absence from the US money markets led to a fresh outbreak of rate worries.

However, most analysts played down the likelihood of an imminent decision to raise rates, the first for five years, although forecasts of a modest tightening in US monetary policy in the next few months are widespread.

The slump in bond markets was put down to frustration with the Bundesbank's ultra-cautious stance on cutting the discount rate, currently 5.75 per cent, which may be explained by Bundesbank irritation with the US for recently pressing for a sharp cut in the discount rate.

Despite the surge in M3, analysts had expected the Bundesbank to act because inflation is easing, wage settlements are softening and the currency has stabilised after falling late last year. The rise in M3, far above the 4-6 per cent target range, was explained by factors that appear to have little bearing on inflation trends, such as a repatriation of German mark funds from Luxembourg to avoid tax penalties and tax incentives for house purchases.