Bundesbank abides by its nein commandment: Germany is in no mood to lower rates, as John Eisenhammer reports

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The Independent Online
ALAN BLINDER could have been standing alone in the middle of the Arizona desert for all the good his tongue-lashing of European central bankers achieved at the weekend.

The vice-chairman of the US Federal Reserve berated his European colleagues for not doing enough to boost employment, notably by easing interest rates. He was joined a few days later by the Organisation for Economic Co-operation and Development which, in its annual report on Germany, stressed there was room and a need for further rate cuts to support the recovery.

Such calls could hardly have been more at odds with the monetary policy climate prevailing in Europe. In Britain, the only question now is when rates will rise. In Italy, the authorities were recently obliged to push up short-term rates. While this was a tactical move, to bolster the lira, it contributed to market sentiment that upward pressure on rates is broadly gathering strength.

France, with punishingly high real interest rates because of its very low inflation, is desperate to cut to ease its unemployment misery. But, as ever, it remains firmly tied to the apron strings of Big Mama Bundesbank.

Here lies the rub. Has the German central bank any more rate- cut aces in its closely held hand? For the foreseeable future, and this includes today's council meeting, the answer appears to be no. Looking even further ahead, the answer changes little - to 'probably not'.

In his terse rejection of Mr Blinder's call for rate cuts, Hans Tietmeyer, president of the Bundesbank, read aloud from the Frankfurt Ten Commandments: 'Monetary policy cannot be expected to make an active and direct contribution to a lasting reduction in unemployment.'

The German central bank never tires of repeating that, come boom or slump, it does not conduct monetary policy with the aim of influencing the short-term performance of the economy. The Bundesbank believes that a sharp cut in interest rates now would do little to help employment, and might, even as early as next year, have an adverse effect by encouraging excessive wage demands.

Close observance of the Bundesbank suggests it is now convinced the German economy is recovering more strongly than many realise. Even eastern Germany is felt to be nearing the promised land of self-sustainable growth. Put bluntly, no further stimulus is required.

In the latter part of last year many economists, wrapped in the gloom of recession, predicted that western Germany would manage little more than stagnation in 1994.

Now, most observers are talking about GDP growth of around 2 per cent. This is an extraordinary turn-about, which has surprised the Bundesbank as much as anyone.

With the recovery gathering momentum almost everywhere, the sensitivity that international financial markets have shown about inflation fears is unlikely to diminish. The Bundesbank worries that any cut in key rates would not help interest rates at the long end - and those are the ones that really count in the German economy.

The central bank is still unsettled by the strong level of M3 money supply growth. The last rate cut, in May, was a bold, unconventional move to drive savers out of short-term deposits, which are part of M3, into longer-term capital. This is gradually occurring. But to get anywhere close to the Bundesbank's maximum 6 per cent target for M3 growth, the monthly money supply data would have to be negative for the rest of 1994, and that is not about to happen quickly.

Certainly, inflation is on the mend, but much more slowly than the Bundesbank itself had counted on. The consumer price data will be markedly improved early next year by a favourable basis effect, as the impact of the sharp fuel price rise in January 1994 drops out. But to infer from this that the road is clear for a further easing of rates is to fall into a confusion often fed by the Bundesbank's own statements.

The full effects of interest rate moves are felt in the German economy about two years later. The fact that inflation looks benign now is, from this medium-term view, neither here nor there.

Far more significant are the effects of the stronger-than-expected improvement in the economy. How soon will manufacturers feel bold enough to raise prices? Above all, how will the next wage round go? This is the determinant for future inflation, and a key variable in the Bundesbank's monetary policy equation over the coming six months.

Some pay negotiations get under way towards the end of this year. Already there have been calls from union heavyweights for the next pay deals to reflect the improving economy, after two years of sacrifices. This is the decisive battle - and while it is on, the Bundesbank is unlikely to be giving much away.

(Photograph and graph omitted)