German rate cut lifts UK hopes: Bundesbank's concern shifts from inflation, with unemployment seen as biggest threat

The Bundesbank yesterday surprised the markets with a half- point reduction in its key lending rates, prompting a wave of European cuts and sharply improving prospects for a cut in UK base rates.

The Bundesbank council cut the all-important discount rate to 5.75 per cent and reduced the Lombard rate, the ceiling for German interest rates, to 6.75 per cent.

Hans Tietmeyer, announcing the first reduction since he took over the central bank presidency at the start of the month, indicated that the Bundesbank had finally gained the upper hand in its long battle with German inflation.

The securities repurchase rate, the main influence on market rates, was chopped by around a quarter- point to 6.4 per cent and Mr Tietmeyer said there was room for further reductions in this rate in the weeks ahead.

London share prices raced to new highs as speculation intensified that Kenneth Clarke, the Chancellor, would authorise a cut in base rates before the 30 November Budget. The FT-SE 100 index jumped by 32 points to 3,188.3, a new closing peak.

Yesterday's German rate reduction and hopes of more to come chased the mark lower across the board, and the pound and the dollar climbed higher. But German and French bond prices slid after Mr Tietmeyer suggested that German long rates, currently near post-war lows, had little further to fall.

Gilts, by contrast, rose by almost half a point while three-month money, a guide to base rate expectations, pointed towards a half-point cut in base rates to 5.5 per cent. Sterling rose by 1.74 pfennigs to a closing DM2.4692 while the dollar advanced by 1.15 pfennigs to DM1.6595.

Mr Tietmeyer said that the progress in fighting inflation and a rising mark had made yesterday's reduction possible. He pointed out that in the latest three months German inflation had slowed to an annualised rate of 2.4 per cent. The annual rate of inflation for October, due shortly, is expected to drop decisively below 4 per cent.

Bundesbank officials are letting it be known that they have grown much more worried about the state of the German economy, signalling that they now regard inflation as a receding threat and rising unemployment as the greater menace.

There were indications yesterday that the regional Bundesbank directors, from the German states or Lander, played a key role in bringing about the reduction in rates, reflecting their growing concern at the weakening German economy.

Some Frankfurt-based officials are understood to have expressed surprise at the council decision. Earlier this week, the central bank said there would be no post-council press conference, dampening hopes of lower rates. But yesterday, during the council meeting, the Bundesbank suddenly announced that a press conference would be held.

The decision is bound to sweeten next week's European summit, especially after the decision sparked a round of European rate cuts, helping to ease the European recession. Belgium, the Netherlands, Switzerland and Austria all reduced their rates and speculation grew that France, Denmark, Spain and Ireland would follow suit next week.

George Magnus, chief international economist at Warburg Securities, said: 'Everywhere across Europe from Scandinavia to Spain will find room to cut rates in the next few days.'

Analysts predicted another German rate reduction before the end of the year and that rates would tumble even further in the new year.

Keith Skeoch, chief economist at James Capel, said: 'This is the start of a big crack in German interest rates taking us down to 3.75 per cent by the third quarter of next year.'