Hopes rise for cut in German loan rates

HOPES that the Bundesbank will throw the European exchange rate mechanism a lifeline by cutting its interest rates on Thursday were boosted yesterday by subdued inflation figures for three key German states.

The French franc escaped the severe selling pressure it suffered late last week, rising a fifth of a centime to close at Fr3.4155 against the mark, 1.5 centimes above its floor in the system. Belgium and Portugal raised key interest rates in an unsuccessful attempt to strengthen their currencies.

The franc's current parity in the ERM received the support - verbal, at least - of George Soros, who made dollars 1bn speculating against the pound last September. 'I am not speculating against the franc and have no intention of doing so because I do not want to be accused of destroying the European Monetary System,' he wrote in the French newspaper Le Figaro.

The pound continued to enjoy its 'safe-haven' status from ERM tension, rising to its highest since the aftermath of Black Wednesday. It gained 1.14 pfennigs against the mark to close at DM2.5869, having traded at a high of over DM2.5950. Hopes of a German interest rate cut and the strength of sterling helped gilts and share prices. The FT-SE 100 index closed up 16.5 points at 2,844.2.

Most economists now expect the Bundesbank to cut its key discount interest rate - the floor for money market rates - by half a percentage point to 6.25 per cent at its policy-making meeting on Thursday. This would give it scope to continue its step-by-step cuts in the 'repo' rate, the one that most closely tracks market rates.

'In the end the Bundesbank always acts to save the EMS. I am sure it will do so this time,' Gerhard Grebe, of Bank Julius Baer in Frankfurt, said.

But some analysts believe a half-point cut will buy the ERM only a brief reprieve at best. 'It will probably not be enough to resolve the tensions,' Neil MacKinnon, economist at Citibank, said. 'It does not allow French interest rates to fall enough to ensure a recovery in 1994.'

The German states of Hesse, Baden-Wurttemberg and North Rhine Westphalia yesterday reported rises in consumer prices of 0.1 or 0.2 per cent, pointing to a national July inflation rate of 4.3 per cent, up from 4.2 per cent in the previous month.

Alison Cottrell, of Midland Global Markets, said the figure - at the lower end of forecasts - left the way open for a half-point off the discount rate, with perhaps three-quarters of a point off the Lombard rate. Ulrich Hombrecher, economist at WestLB, forecast the Bundesbank would cut both the discount and Lombard rates by half a point. 'The EMS is very important for the mid- and long-term economic future,' he said.

But growth in the broad money supply measure M3, which edged up to an annualised 7.1 per cent in June from 6.9 per cent in May, is well above the Bundesbank's target. Hans- Helmut Klotz, of Deutsche Girozentrale, said: 'The Bundesbank will have to rearrange its arguments if it wants to cut rates - the weakness of the franc will decide this.'