Rates cut likely after German lead

FURTHER interest-rate reductions are now likely following a clear signal from the German authorities that they will cut rates again if necessary to boost the German economy.

No change in German rates is expected immediately, but the Bundesbank could reduce German rates in the second quarter or possibly sooner, economists now believe.

Lower German rates would give the Central Bank scope to lower rates here, provided it felt the move would not be overly inflationary. Economists said yesterday that the Central Bank would be unlikely to want Irish rates to fall more than another quarter of a percentage point for fear of fuelling inflation.

Yesterday's reports of comments by the president of the Bundesbank, Dr Hans Tietmeyer, that key German rates might be cut this year if growth in the economy remains weak, sparked off a Europe-wide wave of optimism about interest rates.

However, economists cautioned that it could be up to three months before the key official German discount and Lomhard rates were cut.

The Bundesbank has plenty of scope to ease "unofficial rates" such as the money market Repo rate, possibly as soon as today, points out Mr Jim Power, senior economist with Bank of Ireland group treasury.

If the easing of unofficial rates does not stimulate the economy sufficiently then the Bundesbank will look at cutting the official discount and Lombard rates from their current levels of 3 per cent and 5 per cent.

German rates are at their lowest levels for eight years following the most recent cuts announced in December.

The Central Bank will want to follow any movement in official German rates in order to confirm the linkage between the pound and the deutschmark, according to Mr Dominic Sutton, economist with Gandon Capital Markets.

The Bank will first have to examine the implications for domestic inflation of a further cut in interest rates.

"They would not want to see a bubble in the housing market, for example," he explained.

The Central Bank will also he concerned about the impact of next week's Budget, which is expected to be inflationary, on the already strongly growing economy.

By not cutting rates in line with the Bundesbank the Central Bank runs the risk of the pound appreciating further against sterling, possibly to as high as 105p sterling. The effect of this could be amplified if sterling weakens through a combination of lower British rates and general election fears.

The result is likely to be a compromise, with the Central Bank following the Bundesbank and cutting rates, but not by the same amount.

German rates have the potential to come down by another half of a percentage point, but Irish rates are unlikely to fall by more than another quarter of a percentage point, believes Mr Sutton.

The most recent German economic data paints a gloomy picture. Unemployment is increasing while GDP grew by only 1.9 percent in 1995.

One of the arguments for lower rates is to engineer a weaker mark which would improve the competitiveness of German industry which has had to cope with an exceptionally strong mark in 1995.