Bundesbank cuts rates to save ERM: German central bank chief attacks speculators as quarter-point cut eases tension and boosts sterling

THE BUNDESBANK yesterday bowed to intense international pressure and cut its key interest rates earlier than expected amid mounting fears that the European exchange rate mechanism (ERM) was on the brink of collapse.

The German central bank's decision stabilised sterling and then lifted it sharply against the mark. By the London close, the pound gained more than three pfennigs to finish at DM2.3910. The bounce in sterling relieves fears that its recent weakness might provoke a rise in interest rates.

In the Commons, the Chancellor grudgingly welcomed the Bundesbank move, saying that it could have come earlier. He warned speculators against further attacks on the pound. The markets should remember, he said, that interest rates could go up as well as down.

Tensions, meanwhile, eased in the ERM, lifting the Danish krone off its floor and strengthening the French franc, widely regarded as next in the firing line after the attack on the Danish currency.

Helmut Schlesinger, the Bundesbank President, announced that the key discount rate would be cut by a quarter point to 8 per cent, though the less important Lombard rate was reduced by half a point to 9 per cent.

He expressed the hope that 'currency speculation will now cease' after five European central banks attempted to defend the krone before the Bundesbank move. He decribed the continuing assaults on the ERM as 'an unfriendly domino game in which speculators knock down one currency after another'.

Bundesbank watchers were surprised by the decision to put international considerations first. Germany's independent central bank had earlier set out several domestic preconditions before rates would be cut.

These included low wage settlements, and a 'solidarity pact' between government, opposition, unions and employers, embracing both low wages deals and curbs on public spending.

Mr Schlesinger had difficulty in explaining what looked like a climbdown. 'There are signs of hope on the wages front, and signs of hope on the money supply, but it is only hope. This is not the real reason for our decision,' he said. The Bundesbank President added that the problems of German wages and public spending did not allow further movement in interest rates for the time being. That was taken as a signal that once progress is made on those fronts, more rate cuts could follow.

The German Interior Minister, Rudolf Seiters, who had been leading wage negotiations with the public-sector unions, yesterday expressed optimism that agreement was in sight. Last night the employers' initial offer of 2.25 per cent was raised to 3 per cent and the unions settled.

Although alarm at the depth of the recession has been growing among Bundesbank central council members, hardliners have been resisting pressure for a key interest rate cut until there are clear signs of improvement on the inflation front. Inflation in western Germany reached a peak this month of 4.4 per cent.

In Germany, the Bundesbank's decision drew criticism. The Federation of German Chambers of Commerce said it reduced the chances of price stability, and accused the bank of having given in to political pressure.

British shares hit a new record before the announcement was made but fell back afterwards. In the equity markets, the quarter- point cut was seen as too grudging to permit a significant drop in

European rates, and as limiting the scope for a further British

reduction.

After hitting a record 2900.1, the FT-SE 100 Index closed 7.9 points down, at 2865.9. City economists doubted that the Bundesbank decision would protect the ERM from renewed assault for long, especially if further reductions in German rates were slow in coming.

Amid fresh signs of economic strength in the US, the Dow Jones industrial average closed on a record high, up 43 points at 3417.

The OECD suggested yesterday that Britain may have to raise taxes or cut spending by as much as pounds 10bn and warned that British education was failing the needs of the economy Page 22

Unions agree pay rise, page 10

ERM lifeline, page 22

Hamish McRae, page 23

View from City Road, page 25

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