View from City Road: Frankfurt changes its rhetoric

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For the Bundesbank to play down inflation is unusual at any time. For it to do so when Germany's cost- of-living index is rising relatively strongly is even more surprising.

But this is precisely what has been happening over the past week. Prices rose by 0.3 per cent between March and April, pushing the annual inflation rate up 0.1 point to 4.3 per cent despite the deep German recession. Instead of Frankfurt's inflation-obsessed central bankers squealing in pain, they surprised international markets last week by dropping both the floor and ceiling official interest rates. This was followed yesterday by an unexpectedly large 0.34-point cut in the money market rate to 7.75 per cent.

Their rhetoric is also changing. Helmut Schlesinger, the Bundesbank president, recently hinted that the rate cuts would keep coming. 'It is clear,' he said this week, 'that the change in problems leads to a change in solutions. Someone you might have called a hawk before might be called a dove in the current context.' His deputy, Hans Tietmeyer, pointed out that inflation was a lagging indicator, so that its apparent present strength should not prevent further rate cuts. Mr Schlesinger added that the figures should be interpreted with care, and their significance should 'not be overstated'.

Bundesbank council members are now emphasising that the cost-of- living index is no longer a reliable guide to price developments in Germany because it is distorted by administered price rises, such as rents and municipal services. By contrast, the pressure from import, wholesale and producer prices has weakened considerably. This change of emphasis appears to reflect a shift in the balance on the Bundesbank's central council from the inflation purists towards the recession worriers.

The evident desire to accelerate the process of rate cuts in the face of the mounting evidence that Germany is in its worst post-war recession should not be misconstrued as opening the flood-gates. The strategy of small steps will continue, because conditions allow for little else. While the recent weakness of the dollar has facilitated the latest cuts, the Bundesbank remains sensitive to the fact that the strong mark is living off historic trust and high short-term rates. Germany's economic fundamentals hardly support such strength.

Too bold a cut in rates could prove counter-productive both by pushing the mark out of bed and by ratcheting up long-term interest rates, to which German lending is disproportionately linked. Nevertheless, the Bundesbank now looks on course for 5-6 per cent by the end of the year and maybe as little as 4 per cent next.