Schlesinger dashes rate hopes

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The Independent Online
HELMUT Schlesinger, president of the Bundesbank, moved yesterday to extinguish hopes of an early cut in German interest rates.

At the same time, new tensions in the European exchange rate mechanism broke out following Norway's decision to suspend its link to the ecu.

The Bundesbank also set a more generous target for broad money supply growth next year, lifting the annual target range by one full point to 4.5-6.5 per cent, a move that accommodates the recent rapid expansion of German M3.

The new money supply targets were largely in line with expectations, but the Bundesbank's apparent readiness to allow growth from a higher base, created largely by the monetary expansion following unification, did little to ease tensions on the foreign exchanges.

As Norway suspended its unilateral link to the ecu, the country's central bank chopped key interest rates by 5 points to 11 per cent - the third reduction in recent days - depressing the krone by more than 6 per cent. It will be allowed to float for the next 30 days and the markets expect the devaluation to deepen to 10 per cent from its former central rate against the ecu.

The Norwegian decision, which followed mounting pressure on the krone after Sweden severed its currency link with the ecu, underlined the vulnerability in the ERM of the Danish krone, which fell near its ERM floor and prompted intervention by the Danish central bank.

The Banque de France also stepped into the markets after the French franc fell below Fr3.42 to the mark. It briefly came close to its Fr3.4305 ERM floor, but later recovered slightly to close at Fr3.4165, against Fr3.4120 on Wednesday.

By contrast, two members of the hard currency core of the ERM, Belgium and the Netherlands, were able to shave interest rates as the Belgian franc and Dutch guilder edged up in line with the mark.

In an effort to calm ERM tensions, Mr Schlesinger said the current mark-franc parity was correct and pointed out that the announcement of similar money supply targets by the French and German central banks yesterday underlined the monetary convergence of the two countries.

But Paul Temperton, of Merrill Lynch, said the Norwegian move had 'reawakened fears of another ERM realignment', tempered only by the approaching financial year-end for most foreign exchange trading.

The Bundesbank president said there was 'no room' for further reduction in rates with inflation pressures not yet curbed and the impact of high rates blunted by Germany's swelling budget deficit.

The Bundesbank said that it would hold market rates unchanged at 8.75 per cent until early in the new year. In the financial markets, few analysts expect a reduction in official rates before February, resuming a very gradual easing in German monetary policy begun in September.

A slow reduction in German rates contrasts with the Bundesbank's behaviour in previous interest rate cycles. But analysts do not believe this pattern will be repeated.

Money supply growth accelerated to an annual 10.3 per cent in October, and although the Bundesbank said that growth eased in November, the rate of expansion is expected to remain well above the new target range.

In addition, the German rate of inflation is set to top 4 per cent in January, following a 1-point increase in VAT, compared with a current rate of 3.7 per cent.

The prospect of a drawn-out decline in German rates has prompted analysts to predict a resumption of severe tensions in currency markets in the new year. John Hall, of Swiss Bank Corp, said: 'We will go into January ready for the next battle.'

The pound was little affected by the efforts of the Chancellor, Norman Lamont, to stamp out remaining hopes of a Christmas interest rate cut.

It closed more than half a pfennig lower at DM2.4558.

(Photograph and graph omitted)