Economists said the cut in the 'repo' rate from 8.75 to 8.6 per cent was evidence that the Bundesbank was prepared to ease monetary policy to safeguard the franc's position in the European exchange rate mechanism. The repo rate is closely linked to market rates and is that at which the Bundesbank lends to commercial banks by buying bills from them, which they then have to repurchase later.
The cut also comes amid growing concern about the German economy. Bonn said yesterday that unemployment in the west had risen from 6.3 per cent in 1991 to 6.6 per cent in 1992 and that industrial orders fell by 0.63 per cent in November. It said on Wednesday that industrial output fell by 1 per cent in the same month.
But by leaving the Lombard and discount rates unchanged, the Bundesbank is taking no chances with its domestic reputation as tough on inflation. It keeps up the pressure for moderate wage settlements and a tight budget.
Economists said that the cut in the repo rate suggested that the Lombard and discount rates - the ceiling and floor respectively for market rates - might well be cut next month.
Alison Cottrell, of Midland Global Markets, believes that the discount rate may be cut by 50 basis points to 7.75 per cent and the Lombard rate by 75 basis points to 8.75 per cent as early as 4 February.
Helmut Schlesinger, the Bundesbank president, said the move was 'not a signal, but the continuation of the easing policies seen up until now'; the repo rate has been cut progressively from 9.7 per cent in early September. The French Finance Ministry said the move was 'a sign of good co-operation between France and Germany'.
The Bundesbank's move helped the French franc to pull further away from its lowest permitted level in the ERM. It closed around Fr3.3970 to the mark, its best since early December and more than three centimes above its floor.
Neil MacKinnon, of Citibank, said the German rate cut was a 'very modest gesture', but that 'the franc could be off the hook'. George Magnus, of Warburg Securities, said 'it could still be touch and go, but if official rates come down next month that should be enough to see it through to the March election'. The Union for French Democracy, an important partner in the centre-right coalition expected to win the election, yesterday committed itself to defending the franc's current parity.
But some analysts feared the German move would not be enough to save the franc. 'The French franc is holding steady at the moment, but it is difficult to see that lasting. If the ERM is to survive it needs significant reductions in official interest rates or a general realignment,' Gerard Lyons, of DKB International, said. He added that an early cut in the Lombard rate was unlikely to be matched by the discount rate.
The fate of the punt seems less in doubt. The central banks of Belgium and the Netherlands - whose currencies are the strongest in the ERM - cut their key interest rates by a quarter-point and bought punts in the market, but the currency remained pinned to its floor. This forced the Irish central bank to double its overnight interest rate last night to 100 per cent in a bid to make it prohibitively expensive for dealers to speculate on a devaluation.
Most economists believe that a new Irish coalition government will be announced next Tuesday, and will probably call a meeting of the EC's monetary committee to agree a realignment the following weekend. But some observers believe the punt will not be able to hold out that long.
The pound closed less than a quarter of a pfennig higher against the German mark at DM2.5207. But after the London close it slipped back in New York as the signs of peace breaking out in the ERM robbed sterling of some of its attraction as a 'safe haven'.
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