The increase from 1.7 per cent in the year to July was announced by the Federal Statistics Office, based on provisional figures from four German states. If the new figure is confirmed when full figures are released next month it lifts the inflation rate up to the Bundesbank's target rate.
Capital investment and construction activity remain depressed and unemployment is still high, but the Bundesbank also revised German industrial output figures for June upwards yesterday from 1.4 per cent to 3 per cent, while the International Monetary Fund confirmed forecasts for a buoyant German economy, with growth reaching 2.3 per cent this year and 2.6 per cent next year.
The IMF also said the German government's budget deficit would be 3.1 per cent of gross domestic product this year and could even meet the 3.0 per cent target to qualify for membership of the single European currency.
The majority of dealers and analysts still expect the Bundesbank to delay a response to the figures, especially because Chancellor Helmut Kohl is due to meet the French Prime Minister Lionel Jospin in Bonn on Thursday, the first of a series of ministerial meetings over the next month which will set the tone for progress towards monetary union in 1999.
French finance minister Dominique Strauss-Kahn warned yesterday of an adverse effect on the French government's economic growth target and the French government's attempts to qualify for membership of the European single currency if US or German interest rates rise. As long as they do not raise rates the French economy could expect healthy growth of between 2.9 per cent and 3 per cent next year.
A precautionary rise in German interest rates could however be signalled as early as today when the Bundesbank sets its weekly repo rate at which it will make funds available to the money markets. The rate has been unchanged at 3 per cent for more than a year.
The German stock market shrugged off comments by Chancellor Kohl that he has no intention of reshuffling his cabinet in spite of calls from his coalition partners the CSU for an extra seat to compensate them for the abolition of the ministry of telecommunications later this year.
But anticipating a rise in German interest rates, the dollar fell below 1.82 marks yesterday and German shares failed to recover from Friday's 4 per cent fall. Most shares ended lower in late trading, led by the leading bank shares. Dresdner Bank closed down 3.10 at 73.60 marks.
Elsewhere in Europe trading was generally subdued but stock markets were torn between fears of a rise in German interest rates and optimism inspired by the continuing strength of shares on Wall Street.
The Paris Bourse lost initial gains of around 1 per cent and the CAC- 40 index closed 5.66 lower at 2,898.57 because of worries about the knock- on effects of higher German interest rates. Banks and financial stocks were worst affected.
Car stocks Peugeot and Renault both rallied however, after the French finance minister said a tax on diesel fuel would only be justified if it applied in all EU countries. The shares had fallen last week on fears that the French government would unilaterally apply a tax on diesel fuel to limit pollution. Thomson-CSF and Dassault Aviation continued gains made last Friday after the defence minister confirmed decisions on the future of the two companies would be announced next month.
Swiss shares also closed lower, and the Dutch market lost most of its early gains because of the signals from Germany. But the Italian market still ended the day higher, following the strength of Wall Street.
Shares in New York shrugged off initial losses and the Dow Jones index was almost 60 points higher by mid-morning before suffering a fresh downturn which reduced the gains to 15 points by midday. The market is now waiting for news of US durable goods orders and US consumer confidence figures for July, both due today.
Earlier the Tokyo market was flat but Hong Kong posted gains of around 1 per cent as fears of a run on the currency subsided and the H share index of Chinese stocks rose sharply. Shares in Australia also gained ground, led by gold stocks.