Warning of further trouble ahead for ERM: More countries may devalue or leave system altogether if German interest rates remain high, says OECD

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The Independent Online
THE ORGANISATION for Economic Co-operation and Development is warning privately that the European exchange rate mechanism could be plunged into renewed turmoil this autumn unless German interest rates are reduced more rapidly.

The OECD's forthcoming Economic Outlook, to be published next month, claims that more ERM countries could devalue or even leave the system altogether if they are forced to keep their own interest rates high because of the Bundesbank's cautious approach to monetary policy.

The warning coincides with the latest OECD forecasts, which predict a sharp acceleration in European unemployment and feeble economic growth in the industrial world. The jobless total throughout the 24 OECD member states is poised to reach 35 million this year, a rise of 1 million on last December's predictions.

The OECD thinks German rates are likely to descend by at most 3 percentage points, to 4.5 per cent, by the end of 1994.

OECD officials, who have harboured deep concern over the value of fixed exchange rate systems, fear that tensions in the ERM could persist for several years. They are worried about the stubbornness of German inflation, projected to average 4.9 per cent this year, and the Bundesbank's dilemma in reforging the mark's role as anchor currency of the system.

Next month's Outlook warns that the OECD projection of a rebound in European growth in the second half of 1993 could be jeopardised if German rates are reduced at a snail's pace. If that happens, officials think some countries may experience the British dilemma where high rates were incompatible with mounting unemployment and economic downturn.

The OECD's central prediction, released yesterday ahead of the Outlook analysis, foresees growth at an annual 0.3 per cent in the second half after a 0.7 per cent downturn in the first six months. Officials admit this is the most optimistic of its latest projections. Germany is expected to recover from a 1.9 per cent contraction in 1993 with 1.4 per cent expansion in 1994.

The OECD has upgraded its forecast for British recovery, to be released next month, to around 1.5 per cent for 1993 from an initial projection of 1.2 per cent last December. But even a recovery of such modest proportions is at risk should Europe fail to recover in the second half.

The organisation, whose annual ministerial meeting on world trade talks and prospects for recovery begins today, thinks the industrial world will expand by just 1.2 per cent this year, down from an earlier projection of 1.9 per cent.

Among other issues, the ministerial talks will centre on how to avoid a joblessness rebound. The OECD forecasts that European unemployment will in 1993 average 11.4 per cent of the labour force, rising to 11.9 per cent next year despite a predicted end to recession.

Finance and trade ministers from the industrial world will today receive a new OECD report on unemployment which warns that, since the room for fiscal and monetary stimulus out of recession is exhausted, countries must shift their attention to structural policies, such as greater flexibility of labour markets and spending more on education and training.

But higher spending on the jobless crisis would have to be at the expense of cuts elsewhere. Giving explicit backing to Michael Portillo's root- and-branch review of British public spending, a senior OECD official said: 'Social security and unemployment benefits were conceived at a time of better economic conditions, when there was a lower demand.'