The German central bank left its key discount rate unchanged at 6.75 per cent. Economists in Frankfurt said they were astonished by the decision, predicting that it could trigger a full-blown crisis in the EMS.
'The Bundesbank has remained faithful to its hard self. Things will get very difficult in the EMS now,' Gerhard Grebe, economist at Julius Baer in Frankfurt, said.
Like most economists, Mr Grebe had been expecting the Bundesbank to make a cut of half a percentage point in the discount rate in order to ease the pressure on the weaker European currencies, especially the French franc. The discount rate, which forms the floor for German money market rates, is decisive at a time of falling rates.
The decision by the Bundesbank to cut half a percentage point off its Lombard emergency lending rate to 7.75 per cent was dismissed as symbolic. Calling it a 'small psychological overture to Germany's EMS partners', Ros Lifton of Nomura Research said the Lombard cut was relatively meaningless for money market rates, whose high level is the real reason behind current tensions in the EMS.
The Bundesbank also left the marginal rate for next week's fixed securities repurchase tender, a key guide to money market rates, at an unchanged 6.95 per cent, reinforcing the uncompromising nature of its stance.
A very senior Bundesbank official, speaking on condition of anonymity, said the central bank was caught in a conflict of interests between the domestic economy and external factors. He said the situation on the inflation and money supply fronts had worsened since the last rate cut on 1 July.
'From a domestic point of view, we believe there was no change in the situation which could have justified a further easing in monetary policy,' the official said.
He acknowledged that the markets might be disappointed by the cautious easing of rates. But despite market expectations of a discount-rate cut, the official said: 'We do what we believe is responsible.' He expressed hope that the Lombard rate cut would 'help stabilise the EMS'.
July data showed the annual inflation rate in Germany accelerating to 4.3 per cent, more than twice the Bundesbank's medium-term goal, while June money supply figures showed M3 growing at an annualised 7.1 per cent, way above the central bank's target corridor.
The Bundesbank clearly felt that if it had dropped its discount rate against such a poor background, it would have been interpreted as a political move, casting doubt on the central bank's prime duty of combating inflation and safeguarding the mark.
'The Bundesbank realised it was in a no-win situation, and so decided to protect is own reputation,' Mr Grebe said.
However, while many economists were predicting an intensification of the EMS tensions, they were also convinced that at yesterday's meeting, the last one before a four-week summer break, the Bundesbank will have laid emergency interest-rate plans should a full-blown crisis erupt.
'I am sure that they have agreed on an advance move in case things get serious,' Norbert Walter, chief economist at Deutsche Bank, said.
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