Commentary: Germany will show the way down

Downward cycles in interest rates always move in fits and starts and markets often run ahead of the trend. The monetary events of 1992 bear this out. Markets have looked for lower German rates since the first quarter of the year, but were forced to wait until the third quarter before the Bundesbank obliged with a grudging cut.

Now there are signs that Germany could lead a general drop in rates worldwide. German recessionary forces have gathered momentum since the Bundesbank cut the Lombard rate by a quarter of a point - the first drop in rates in five years - in early September. Yesterday brought the second signal in as many weeks that the Bundesbank wants to see market rates come down. This has understandably fuelled speculation that the next drop in official rates is not far off.

Hans Tietmeyer, the Bundesbank vice president, yesterday made the obligatory noises about inflationary threats. But close attention must be paid to his emphasis on the council's new readiness to review the level of official rates at every forthcoming meeting.

An early drop in official German rates therefore looks a racing certainty and should clear the way for another cut in base rates in Britain. Elsewhere in Europe, rates pushed up by the European currency crisis can come down too. Speculation is also rife that Japanese rates will soon come down and plenty of money still rides on another US rate cut after the election.

But for Europe at least, the key to lower rates is the Bundesbank. Yesterday brought a technical decision to return to a floating-rate outcome at the weekly securities repurchase pacts, replacing the temporary fixed-rate tenders introduced to cope with the monetary bulge brought on by Bundesbank intervention last month.

More importantly, Bundesbank officials have slipped the word that they want to see market rates move down a bit from the 8.90 per cent rate fixed at the last tender.

At today's tender, the markets are expecting the rate to fall, perhaps as low as 8.50 per cent, raising hopes that the next cut in official rates is only weeks away.

On the way up, the rate to watch was the Lombard rate. Now pitched at 9.50 per cent, it looks increasingly irrelevant to market trends and seems designed to underscore the Bundesbank's continuing concerns over inflation. The Discount rate, at 8.25 per cent, sets an effective floor for a market inclined to push rates downwards. This is the rate to watch and some hope for a reduction next week.

This may prove too optimistic. But it is no longer unreasonable to discount, as the markets now do, a half-point drop in official rates by Christmas.