Dollar Surges on Sudden German Interest Rate Cut

In a surprise turnabout, Germany on Thursday cut short-term interest rates, a move that could halt the U.S. dollar’s slide and signal that central banks are becoming less fearful of inflation and more worried about keeping the world 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.

In Tokyo, meanwhile, the Bank of Japan confirmed today that it has helped push key short-term interest rates in Japan to record lows this week--under 2%--though it is “undecided” about an official cut in lending rates.

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

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 maintaining the availability of money to fuel economic activity.

Central bankers “may be saying we’ve been fighting the ‘last war’ ” in supporting 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--denied that they have changed policy, and they offered a much narrower explanation for their rate decision.

In reducing the discount rate, the central bank’s 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” because of global currency fluctuations.

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 firms 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, it had room to lower interest rates without threatening to overheat 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 followed 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 with other central banks.

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.

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

Now, as German interest rates fall 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, at the expense of German securities. At 4% now, the German discount rate is well below the Fed’s discount rate of 5.25%.

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

Whether the German move can spark a sustained turnaround in the dollar-mark relationship, however, is not clear. The dollar has slumped about 10% versus the mark and yen this year.

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

“If the market is now looking for an underlying trend (for the dollar), it is upward,” argued Ulrich Beckmann, a currency specialist at DB Research in Frankfurt.

Others are not so sure, noting that the twin U.S. deficits guarantee that the world will remain awash in dollars at least near-term. “I don’t think this does a lot for the dollar,” said Kevin Logan, economist at Swiss Bank Corp.

For U.S. firms, the weak dollar is a boon in that it cuts prices of U.S. exports. Even so, a continuing free fall in the currency could offset those benefits if it were to cause a global panic.

The biggest beneficiaries of Germany’s rate cut may be other European nations. Many of them have had to maintain high interest rates in attempts to retain capital that otherwise might have flowed 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 cut their own interest rates Thursday.

But some analysts say the German move may be as much a defensive step as one aimed at helping other 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” in Europe, he said.

Similarly, the Bank of Japan has reasons other than the strong yen to lower rates, 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.

In any case, some economists say they are encouraged by central banks’ willingness to lower interest rates further--or in the case of the Fed, to hold steady--even as the global economy maintains a relatively strong pace of growth.

The extraordinarily competitive nature of the world economy--the result of freer trade, technology-driven productivity gains and free capital flows--should keep annualized inflation under 3% in most developed countries this year, experts say.

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

Whether that trend will continue, 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.