Commentary: All eyes on Germany

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Perhaps the most closely watched indicator in Europe these days is the German money supply. Yesterday brought another shocking figure that helps to explain why the Bundesbank raised the discount rate last week. Broad M3 money supply - which the Bundesbank sees as the key indicator of inflationary pressures - grew by an annualised 8.7 per cent in June.

Nevertheless, the rate of expansion has been slowing, albeit at a snail's pace, from almost 9 per cent in April. Thoughtful analysts in London and Frankfurt expect this to continue for the rest of the year. Some of the expansion is being fuelled by special factors, like subsidised credits to eastern Germany.

A rise in cash in circulation last month is also thought to reflect hoarding of marks in Eastern Europe. Money is flooding into short-term deposits - a component of M3 - lured by high rates.

Nevertheless, bank credits are still growing sharply and serve to underline Bundesbank worries over inflation. There is therefore no chance that M3 will fall within the annual 3.5 to 5.5 per cent target range this year.

This means that a gradual slowdown in M3 growth is likely. German rates are unlikely to fall this year, which means the country must endure the toughest monetary regime since the Second World War. It may be only a question of time before the real economy is hit.

But as long as the market expects the M3 growth rate to stay above 8 per cent in the next few months, it will remain worried that German rates, and those elsewhere in Europe, could rise. It is going to be a long hard summer.