Dollar Surges on Sudden German Interest Rate Cut

In a surprise turnabout, Germany’s central bank on Thursday cut short-term interest rates, a move that could halt the slide of the U.S. dollar and signal that major governments are becoming less concerned with inflation and more worried about keeping the global economy growing.

The unexpected half-point rate cut was immediately followed by similar cuts across Europe and sent the beleaguered dollar surging in value against the German mark.

Moreover, the German move has been matched by efforts by the Bank of Japan to push short-term interest rates in Japan to record lows in recent days, economists note.

The sudden action by the world’s major central banks, after three months of extraordinary volatility in key currency values, appears to be a concerted effort to restore some order to foreign exchange rates--or at least put a floor under the sinking dollar’s value.

Perhaps more important, some economists believe that Germany’s rate cut, and this week’s decision by the U.S. Federal Reserve Board to leave short-term interest rates in the United States unchanged, constitute a significant policy shift away from high interest rates and toward easing the availability of money to fuel economic activity.

Central bankers “may be saying we’ve been fighting the ‘last war’ ” in maintaining relatively high interest rates in a world where inflation is by and large tamed, said C. Fred Bergsten, head of the Institute for International Economics in Washington.

Authorities at Germany’s Bundesbank--whose reputation has been that of an ardent inflation-fighter even if it meant recession in Europe--offered a much narrower explanation for their rate decision. In reducing the discount rate, the central-bank rate on loans to German banks, to a six-year low of 4% from 4.5%, the Bundesbank said it was acting because “monetary conditions in Germany have changed due to the strong external value of the (mark).”

The surge in the mark’s value this year versus the dollar and other European currencies, a move driven by market forces, has hurt German exporting companies by raising the prices of their goods abroad.

Thus, because of the drag effect of the strong mark on the German economy, the Bundesbank implied, the bank had room to lower interest rates without threatening to heat up the German economy and raise inflationary pressures.

The cut in the discount rate, and a smaller reduction in another key interest rate, were the first since May, 1994, and were announced in Frankfurt after a routine meeting of the bank’s directorate.

In an interview with the German economic service VWD, Bundesbank President Hans Tietmeyer said the rate cuts were not coordinated in advance with other central banks. “(They were) a result of an assessment of the options available to us,” he said.

In addition, the Bundesbank denied that its action was aimed at stabilizing currency values. “The Bundesbank . . . is not pursuing a foreign exchange goal,” it said.

Nonetheless, the dollar jumped sharply in value against the mark, closing in New York at 1.409 marks, up from 1.383 on Wednesday.

The dollar also rose to 89.58 Japanese yen, up from 88.39 on Wednesday.

Despite Tietmeyer’s denial of coordination with other central banks, he has in recent weeks voiced the view that the dollar had fallen too far--a statement repeated by Federal Reserve Chairman Alan Greenspan.

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By reducing German interest rates while the Fed holds U.S. rates steady, the dollar would be expected to gain in value by attracting more global investors to U.S. bonds and money-market securities, at the expense of German securities.

Bergsten noted that central banks generally “don’t like it to look as if they are coordinating” because the mystique of complete independence is key to maintaining the banks’ image of power over financial markets.

Whether the German move will be enough to spark a sustained turnaround in the dollar-mark relationship, however, isn’t clear.

Some experts believe that the slide in the dollar this year, ostensibly because of global investors’ concerns about still-mammoth U.S. budget and trade deficits, has been overdone and that the market was just waiting for concrete steps by central banks to arrest the decline.

“If the market is now looking for an underlying trend (for the dollar), it is upward,” argues Ulrich Beckmann, a currency specialist at DB Research, an arm of Deutsche Bank in Frankfurt. “I’m no longer worried that we haven’t seen the turnaround.”

Others are not so sure. “I don’t think this does a lot for the dollar,” said Kevin Logan, economist at Swiss Bank Corp. in New York. He noted that many world central banks themselves have been selling dollars and buying mark- and yen-denominated securities to diversify their “reserve” currency holdings away from the still-dominant dollar.

The biggest beneficiaries of Germany’s rate cut may be smaller European nations. Many of them have been forced to maintain high interest rates in attempts to retain capital that otherwise might have joined the flight into the strong German mark.

“Italy has double-digit interest rates, and so does Sweden and Spain,” Wall Street economist Henry Kaufman said. “This takes some pressure off them.”

Indeed, central banks of Switzerland, the Netherlands, Austria and Belgium quickly followed the Bundesbank action with their own interest rate cuts Thursday.

But some analysts say the German move may be as much a defensive step by Germany as one aimed at helping European economies stay on a growth track.

By raising prices of German goods abroad, while essentially lowering prices of imports from other European countries, the strong mark has been slamming major German companies, noted David Resler, economist at Nomura Securities in New York. “I think the Bundesbank realized that they weren’t getting their fair share of growth out of Europe,” he said.

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Similarly, the Bank of Japan has been pushing short-term interest rates lower for selfish reasons beyond the weak dollar’s impact, experts say. The Japanese stock market has been plunging; the devastating Kobe earthquake has taken a toll on the economy, and the recent terrorist attack on a Tokyo subway has shaken the national psyche.

The extraordinarily competitive nature of the global economy today means that central banks may believe that they can afford to be less concerned about inflation, some experts say.

“We have nothing like the degree of inflation that would be normal at this stage of the economic cycle,” said David Jones, economist at bond dealer Aubrey Lanston & Co. in New York.

Whether that trend will continued, however, remains to be seen. Economists say the risk in the Bundesbank and other central banks appearing too accommodative is that any sudden resurgence in inflation pressures could spark a backlash in world financial markets--and quickly drive short- and long-term interest rates higher.

Marshall reported from Berlin and Petruno from Los Angeles.