Cut rates, Bundesbank told: OECD sees no sign of end to western German recession

THE ORGANISATION for Economic Co-operation and Development has urged the Bundesbank to cut interest rates. But the German central bank yesterday appeared to play down hopes for early reductions.

Forecasting a slower recovery than the Bonn government anticipates, the Paris-based forecasting organisation said there were no indications of an end to recession in western Germany.

However, the OECD's latest report on the German economy lent some support to the Bundesbank when it warned that despite the room for lower short-term rates, aggressive reductions should be avoided because of Germany's current account deficit and comparatively high inflation rate.

The Bundesbank's latest monthly report agreed that the scope for lower rates has widened, because of government plans to cut spending and curtail the expanding budget deficit. But it warned that monetary growth and prices rising at an annual rate of 4.2 per cent were still too high, limiting the room for rate reductions.

The OECD expects western German output to fall 2.5 per cent this year and edge up 1 per cent in 1994. For all Germany, output is predicted to shrink 1.9 per cent this year, returning to an expansion rate of 1.4 per cent in 1994.

However, Bonn yesterday maintained that real GDP in western Germany stabilised in the second quarter, suggesting some grounds for optimism.

The Bundesbank meanwhile warned its European partners to use with care the scope for more flexible monetary policies, created by the recent widening of exchange rate mechanism bands. Progress towards European economic and monetary union need not be held up by ERM reforms, the Bundesbank said, but it would depend crucially 'on whether and how soon the economic and political conditions for a common currency can be fulfilled'. It urged its ERM partners 'to exploit this monetary policy scope with circumspection,' holding to goals of price stability and avoiding the short-term competitive advantages of lower exchange rates.

The OECD was relatively optimistic on the outlook for German inflation, predicting that, excluding the impact of higher indirect taxes, the Bundesbank may come close to its target of a 2 per cent rate by the end of 1994.

The OECD said that despite higher taxes, the general budget deficit could hit DM130bn, or 4 per cent of national output, this year, rising to 4.5 per cent in 1994. This would largely reflect the fall in revenues and rise in spending due to recession. Government policies have in fact ensured a withdrawal of demand stimulus equivalent to 1 per cent of GDP.

Borrowing by the Treuhand, the eastern German privatisation agency, and the railways, adds another 1.5 per cent to the deficit as a proportion of national output. In 1995, the federal government will assume responsibility for this debt in addition to the debt of the former East German state.