German Rate Cut Seen as Blow to Exchange Rate System

Germany’s central bank dealt what may be a lethal blow to Western Europe’s system of fixed exchange rates Thursday by making only a token cut in Germany’s high interest rates.

Traders on the international currency markets, most of whom had expected more substantial action in Germany, immediately began selling the currencies of Belgium, Denmark, Spain and--most significantly--France.

Only heavy intervention in the markets by most of the European Community’s central banks prevented those currencies from falling below their minimum allowable levels against the German mark.

Many analysts predicted the imminent collapse of Europe’s so-called exchange rate mechanism, which was designed to ensure stability in EC currency markets but, for the last year, has mostly made them more volatile.

“I’m talking days rather than weeks or months,” said Paul Chertkow, head of global currency research in the London office of the United Bank of Switzerland. Under present circumstances, he said, the exchange rate mechanism is “unsustainable.”

John Hall, an economist with Swiss Bank Corp. in London, said he had not yet written off the mechanism, although he admitted that the chances of its demise “have increased markedly.”

The action by Germany’s Bundesbank strengthened the dollar on international currency markets as investors--sensing turmoil in Europe--apparently turned to the dollar as a safe haven.

Normally, higher-than-expected interest rates in Germany would depress the dollar. But on Thursday, the dollar bought 1.742 marks in New York trading, up from Wednesday’s close of 1.718.

The Bundesbank’s governing council trimmed its so-called Lombard rate by 0.5, to 7.75%. The Lombard rate, available to commercial banks that cannot get overnight loans elsewhere, acts as a ceiling on short-term interest rates in Germany.

More important was what the Bundesbank did not do: It did not trim the discount rate, which serves as a floor on short-term interest rates, from its current level of 6.75%.

At a time when the trend in interest rates is down, as it is now in Germany, the Lombard rate hardly matters, because most banks can get cheaper money elsewhere. A spokesman for the German auto maker BMW called Thursday’s rate cut an optical illusion, “because the Lombard rate is almost not used anymore.”