ERM Realignment: Bundesbank forced to bow to political needs

IT IS widely expected that the Bundesbank central council will announce a reduction in Germany's leading interest rate during its hastily summoned extraordinary meeting this morning.

The announcement of a planned cut, which was not confirmed by the Bundesbank itself, came in Brussels yesterday from the European Community's monetary committee, after it had agreed upon a devaluation of the Italian lira against the other EC currencies. The German Finance Minister, Theo Waigel, said that the 'expected interest rate cut by the Bundesbank would further improve the conditions for stronger growth in Germany and Europe'.

The expected decision in Frankfurt today will be a far from easy one for the Bundesbank, and is likely to be opposed bitterly by hardliners on the central council. Should the reduction occur, after the central bank has spent the past months letting it be known that the market should not expect a reduction in the Lombard rate from its present high of 9.75 per cent before next year, it would underline the extent to which international and domestic political pressures on the Bundesbank had simply become irresistable.

The turbulence in the European currency markets over recent weeks, and the plunge of the US dollar against the ever mightier German mark have driven the Bundesbank into a position where it is being held directly responsible for the economic misery of most of its partners. The pressure from abroad has reached an unprecedented intensity, as governments argued that a quick reduction in the German rate, which sets the floor for other European rates, would create the conditions for a desperately needed boost to recession-struck economies. Furthermore, a German rate cut now could tip the balance definitively in favour of the pro-Maastricht campaigners in the final week before the French EC referendum.

The mixture of pleas and threats from abroad was readily passed on to the Bundesbank, which acts autonomously, by the Bonn government, itself desperate for a rate cut at home. The German economy is slowing down rapidly, with the vital export machine virtually at a standstill. With unification proving far more costly than imagined, the Bonn government desperately needs to boost the western German economy through cheaper credit.

The Bundesbank cannot be happy, however, if it is forced into doing what it clearly still does not want to do. For even though it is aware of the agony being caused by high German rates on weaker European economies, this has only been a secondary consideration for a bank whose overriding concern is to secure monetary stability at home. But the problems which led the bank to raise the Lombard rate to 9.75 per cent, and most recently the discount rate to 8.75 per cent, are still present. Inflation, while lower, remains obstinately above 3.5 per cent, well over the bank's 2 per cent target. The rate of expansion of the money supply is also still way out of line. Furthermore, the growth in public spending in the west, by the Bonn government and those of the federal states, shows little sign of being cut in the radical way demanded by the Bundesbank, in order to reduce the pressure caused by huge financial transfers to the east.

For these reasons the Bundesbank wanted, and intended, to keep up the domestic pressure, until it was satisfied that stability had been secured. The strong rise of the mark against other European currencies, and espcially the dollar, appears however, to have put paid to this policy. In extremis, international politics have prevailed.

----------------------------------------------------------------- NEW CURRENCY RATES ----------------------------------------------------------------- Country New rate/Ecu Old rate Belgian franc 42.0639 42.4032 Luxembourg franc 42.0639 42.4032 German mark 2.03942 2.05586 Danish krone 7.77921 7.84195 Spanish peseta 132.562 133.631 French franc 6.83992 6.89509 British pound 0.691328 0.696904 Irish punt 0.761276 0.767417 Italian lira 1636.61 1538.24 Dutch guilder 2.29789 2.31643 Portuguese escudo 177.305 178.735 ----------------------------------------------------------------- The drachma is the only EC currency which is not yet within the Exchange Rate Mechanism. Source: Reuters -----------------------------------------------------------------

(Photograph omitted)