Bundesbank signals loan rate cut

HOPES of further interest rate cuts mounted yesterday after the Bundesbank signalled it was ready to see German market rates fall.

Share prices advanced as predictions of lower rates were mixed with relief that the Government may survive today's vote on pit closures. The FT-SE 100 index closed 54.8 points higher at 2,617.0, the strongest gain since the pound was devalued last month.

Speculation that lower German rates would soon lead to a drop in official rates drove the dollar up sharply while the pound benefitted from the weakness of the mark. In London, the US currency closed 3.5 pfennigs higher at DM1.5190. The dollar was also helped by some signs of life in the US economy as housing starts rose by 1.4 per cent in September. But August figures were revised to show a strong 12.6 per cent increase in starts.

The pound jumped by 3.53 pfennigs to DM2.4559, and against a weighted basket of currencies, sterling closed 0.7 points higher at 80.2 per cent of its 1985 value. Though Britain no longer has an exchange rate target it is thought unlikely that the Chancellor would risk another cut in base rates unless sterling were reasonably firm. Despite renewed hopes of lower rates, the Treasury said yesterday that the two recent reductions and the fall in the pound since Black Wednesday amounted to a 'substantial loosening' in monetary policy.

But official UK figures yesterday pointed to a further economic relapse with the disclosure that broad money supply grew at the slowest rate since 1982 and lending dropped for the first time since records started 10 years ago.

Lending by banks and building societies fell by pounds 700m, the first fall recorded since July 1982. The growth of broad money supply, M4, slowed from an annual 5.5 per cent to 5.1 per cent in the year to September, also the lowest since 1982. According to research by Salomon Brothers, the US investment firm, the M4 growth rate is now the slowest since the early 1960s. Narrow money supply meanwhile rose 0.4 points in September, bringing the expansion in the year to September to 2.1 per cent, little changed from the previous month.

Despite the implication that the economy sank deeper into recession last month, the Treasury said the figures were 'consistent with the picture that led up to Friday's decision to cut base rates to 8 per cent.'

Other highlights included a steep pounds 12.7bn slump in external and foreign currency finance of the public sector, thought largely to reflect the scale of the defence of sterling last month. A pounds 10.5bn jump in other external and foreign currency flows appeared to represent much of the speculative pressure on the pound in September.

Speculation over German rates was fuelled when the Bundesbank announced it was reverting to a variable rate tender at the weekly securities repurchase pacts and hinted that it wanted to see a decline in rates at today's tender. Hans Tietmeyer, the Bundesbank vice-president, said the central bank remained concerned about inflation pressures and, despite distortions, the rapid growth in Germany's broad money supply.

But he added that M3 growth was not the only factor guiding monetary policy. Strong currency inflows and German competitiveness - an apparent allusion to the damage that the strengthening mark was wreaking on German industry - also had to be taken into account. As a result, Mr Tietmeyer said the level of official rates would be examined regularly at Bundesbank council meetings.

The Bundesbank vice-president also appeared to climb down from earlier insistence that the European Monetary System did not need to be reformed. After an apparent gesture to Britain at last Friday's special EC Summit in Birmingham, Mr Tietmeyer said EMS rules would have to be 're- examined'. A meeting of the EC Monetary Committee this Friday will begin a review of operating rules for the system and 'errors in policy' committed by some countries during the recent crisis.

However, this is not seen as the fundamental overhaul of the system on which Britain once insisted, but is instead a Community response to US requests for an examination of the world capital markets after the European crisis.

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