Bonds surge as France cuts rates

Click to follow

Economics Editor

The French bond market rallied as the Bank of France yesterday lowered interest rates and striking railway workers voted to return to work. But with fresh signs of weakness in France's main trading partner, Germany, analysts warned that the flagging French economy might not revive even with further rate cuts. A sombre report warned that the French banking system was in a state of depression.

Bonds surged in response to the easing in monetary policy, with the yield on long-dated stock falling by almost 10 basis points. The franc strengthened by a centime against the mark to close at 3.44, but the stock market lost some of the gains it had made on Thursday with the CAC-40 index ending 16 points down at 1859.25.

The Bank of France cut the intervention rate, which sets a floor to money market rates, from 4.7 to 4.45 per cent. Jean-Claude Trichet, governor of the central bank, said the cut had been made "because the franc is stable, inflation has been contained and the monetary aggregates are developing favourably".

With the intervention rate still 70 basis points above the new German repo rate of 3.75 per cent, analysts said there was scope for a further reduction of half a per cent. Until the currency crisis of the spring, the French central bank had maintained a margin of 20 basis points above the repo rate.

"But even the interest rate cuts that are possible won't be enough to revive the economy," warned Julian Jessop, economist at HSBC Markets, which is projecting growth of about 1.5 per cent next year.

As a result, he said, the budget deficit next year could be as high as 4.7 per cent rather than the 4 per cent targeted by the French government. This would make it unlikely that France could conform with the criterion of 3 per cent or less in 1997 set by the Maastricht Treaty for eligibility to monetary union.

An extremely sharp decline in west German manufacturing orders in October suggested that France was unlikely to receive much stimulus from an early pick-up in the stalled German economy. Total orders fell 4.5 per cent in October.

On the brighter side, a survey of business confidence in western Germany by IFO for November showed the first rise in confidence since May.

The need for steps to revive the French economy was highlighted by a pessimistic report about the health of French banks from AFB, the French banking association. Net banking income had fallen 6 per cent in 1994 and 7 per cent in the first half of 1995 - a nosedive unprecedented since the war.