In what was seen as an enthusiastic response to the Bonn government's plan for radical public spending cuts the discount rate - which provides a floor under market rates - was cut by half a point to 6.75 per cent. The move marked a new determination by the central bank to boost the economy.
The Lombard rate was also cut, by a quarter point to 8.25 per cent, and the short-term repurchase rate by around three-tenths of a point to 7.3 per cent.
The Bundesbank's announcement triggered a wave of interest rate cuts across Europe. Belgium, the Netherlands, Austria, Ireland, Sweden, Denmark and Switzerland all reduced their borrowing costs. France left its rates unchanged as the franc fell to a one-month low of Fr3.3780 to the mark in afternoon trading.
The Treasury welcomed the German rate cut, but said the British base rate - currently 6 per cent - was consistent with recovery and the Government's target for inflation. But the Labour Party called for an immediate rate cut in the wake of the German move, citing falls in retail sales and rising business failures as evidence that the economy remained sluggish.
The mark dipped slightly on the cut, but then rose strongly as dealers concluded that another German rate reduction was now unlikely until the autumn. The mark was also helped by a weak dollar, depressed by further evidence of weakness in the US economy as the purchasing managers' index suggested that factory output was falling. The dollar shed almost half a pfennig to DM1.6970, while the pound rose nearly a cent to dollars 1.5070.
A confident Helmut Schlesinger, the Bundesbank president, said the German recession had reached the bottom and the economy was showing signs of improvement. He dismissed recent external pressure for interest rate cuts, notably from France and America.
Mr Schlesinger said the Bundesbank's decision was based on a number of improved domestic factors. International rumours about the demise of the mark had been proved unfounded. 'The very fact that we took such a clear step on rates points up that our confidence in our stability policies is extremely large,' he said.
Talking after the annual external meeting of the bank's central council, held in Leipzig on the third anniversary of monetary union between west and east Germany, Mr Schlesinger said he was confident the German economy had bottomed. 'From now on it can improve,' he said. Industrial orders were rising and the slide in industrial production had halted. In April and May it had risen slightly.
The reasons for the Bundesbank's upbeat mood, and the larger-than- expected discount rate cut, lay partly in improvements in inflation and the deceleration in money supply growth.
Although it was still over 4 per cent Mr Schlesinger said that 'the inflation figures show over the past three months that growth has been much weaker than year-to-year comparisons suggest'. He said M3 money supply growth was not as strong as it had been. Mr Schlesinger reserved special praise for Bonn. The DM20bn deficit reduction package for 1994 agreed earlier this week by the centre-right coalition was an important development, he said. He particularly welcomed the fact that this package focused on cuts in spending, as opposed to the earlier Solidarity pact, which had emphasised increasing revenues.
One of the main reasons, in the view of economists, why the Bundesbank called a halt in late April to its policy of regular, cautious rate cuts, was alarm at the exploding public deficit. The Bundesbank had warned repeatedly that the government's seeming inability to curb a public deficit that will reach 7.5 per cent of gross domestic product this year, was preventing further rate cuts.
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