Bundesbank trims two key rates by 0.25pc in surprise move

THE Bundesbank surprised financial markets yesterday with a quarter-point cut in its leading interest rates.

After a meeting of its policy-making council, the central bank decided to cut its discount rate to five per cent from 5.25 per cent and its Lombard rate to 6.50 per cent from 6.75 per cent.

The move was almost immediately echoed by central banks in many other European countries.

In London the FTSE index closed at 3,131.7 points, down 14.1, but pulled off lows by the Bundesbank cut, while in New York at noon the Dow was up 7.43 points to 3,668.9.

Economists and dealers had only expected a symbolic cut in the bank's less important Lombard rate and few had looked for a cut in the discount rate.

Germany Finance Minister Theo Waigel called the cuts ''a great help'' to the government in its bid to strengthen the economy.

Analysts said the cuts were made possible by western Germany's steadily falling inflation rate, which was 3.2 per cent on an annual basis in March, down from 4.3 per cent last September.

''Lower inflation allowed the Bundesbank to make the cuts, but the fact that Germany's economy is still wobbly made them necessary,'' said Peter Pietsch, senior economist at Commerzbank in Frankfurt.

The discount rate, the rate the Bundesbank charges on loans to financial institutions and the cheapest form of bank refinancing, is considered a symbolic tool of monetary policy that serves as the central bank's primary indicator of conditions for borrowing.

The Lombard rate, the rate at which banks can borrow emergency funds from the central banks, has become less vital for financial markets because it serves as a ceiling on overnight rates and does not impinge on money market rates at a time when they arebiased in a downward direction.

Both are applied on short-term loans to commercial banks that post various types of securities as collaterals.

The Bundesbank closely links any easing of interest rates to a slowing in inflation and the latest cut is a continuation of its policy of a ''step-by-step reduction in interest rates''.

In the wake of the Bundesbank cut Austria trimmed its discount rate to 4.75 per cent and its Lombard rate to 5.75 per cent, while Switzerland's central bank cut its discount rate to 3.5 per cent.

The Dutch central bank cut its advances rate, the main interest rate, to 4.75 per cent from five per cent and the National Bank of Belgium trimmed its central directive interest rate by 0.15 percentage points from 5.95 to 5.8 per cent.

The Danish central bank cut the discount and key deposit rates to 5.25 per cent from 5.5 per cent.

But the Bank of France, hamstrung by the franc's weakness, would bide its time before following the Bundesbank in cutting rates, economists said.

Bundesbank president, Hans Tietmeyer, said the central bank's highest priority remained reducing inflation and that he believed German inflation could be brought under three per cent by the second half of the year.

Mr Tietmeyer said the decision was in line with the central bank's policy of small rate cuts.

But Mr Tietmeyer warned against cutting interest rates too quickly.

''Premature rate cuts would raise inflationary expectations,'' he said.

Mr Pietsch said further cuts in the securities repurchase or repo rate were now the key issue for German economic recovery.

The central bank did not make any comment about its next round of securities repurchase agreements.

Mr Pietsch said the Bundesbank's small weekly repo rate cuts, which have allowed the repo rate to drop to 5.7 per cent from six per cent in February, needed to be accelerated.

''If the small repo rate cuts continue, [yesterday's] discount and Lombard rate cuts will not mean very much,'' he said.

''But I think the Bundesbank will trim the repo rate by some 20 basis points either next week or the week after,'' he said.

The Bundesbank's weekly securities repurchase rate sets the trend for money-market interest rates.

The Bundesbank said its policy-making Central Bank Council meeting in Frankfurt took into account hopes that the inflation rate would decline in the future and that the pace of German M3 money supply growth would slow in the coming months.

The broad M3, including cash, savings, short-term loans and other financial instruments, grew 17.5 per cent in February on an annualised, seasonally adjusted basis, well outside the central bank's four per cent to six per cent 1994 growth target range.

Germany's high interest rates in the wake of German re-unification have been cited as a drag on European economic recovery.

The high interest rates have siphoned off investment from other major European currencies and the US dollar into the mark.