German Central Bank Cuts More Key Rates : Credit: Discount and Lombard emergency funding rates drop half a point. Other European nations respond with similar actions.

The German Bundesbank slashed key interest rates Thursday to their lowest level since December, 1988, sparking rate cuts in core European nations, sending U.S. yields lower and possibly marking the end of three years of falling German credit costs.

The official rate cuts, the first since March, took the discount rate, the floor for German short-term rates, to 3.5% from 4%. The Lombard emergency funding rate was reduced to 5.5% from 6%.

Austria, Denmark, Belgium and the Netherlands all cut their discount rates and money market rates in response, and Portugal was expected to ease its policy soon. Analysts said the German move makes a British rate increase even less likely.

A brief statement after a regular meeting of the Bundesbank policy-making council said sluggish developments in its key policy barometer--the M3 money supply--prompted the move.

“The main reason for the interest rate cut was the continued weak development of the money supply,” the Bundesbank said. It made no further comment.

The M3 money supply points to inflation two to three years down the road.

Data released earlier in the week showed that M3 contracted at an annualized rate of 0.4% in July from the fourth quarter of 1994, far from the Bundesbank’s target growth corridor of 4% to 6%.

Economists said this data, combined with favorable inflation numbers from three German states, delivered the Bundesbank the perfect opportunity Thursday for a rate cut.

“The cut fit perfectly with the economic situation,” said Hermann Remsperger, chief economist at BHF Bank in Frankfurt. “M3, inflation and the continued weakness of the economy all pointed in the right direction. What would they gain by waiting to mid-September or the end of September?”

German Finance Minister Theo Waigel welcomed the rate cuts, saying they would improve prospects for inflation-free growth.

“As a result of today’s decision by the Bundesbank, the forces for inflation-free growth in Germany will be strengthened further,” he said in a statement.

In Tokyo, a senior Japanese official said the rate cuts were in line with currency coordination between the Group of Three richest nations--Germany, Japan and the United States.

The big three last week stormed into currency markets to snap up dollars, pushing the currency to a new six-month high. Thursday’s Bundesbank move briefly took the U.S. currency back up to those levels, just below 1.50 marks.

The dollar slipped to 1.4740 German marks in New York trading, down from 1.483 marks late Wednesday.

In advance of the Bundesbank meeting, analysts’ views had been split, with some expecting the central bank to keep rate cut hopes alive by holding off on a discount rate reduction.

Some had said fears that the easing--rated almost unanimously by economists as the last this cycle--could send off alarm bells in German bond markets and would stay the Bundesbank’s hand. Falling interest rates normally support bond prices.

Indeed, bunds reacted badly to the news, with the September future dropping 20 basis points to 94.86 by late afternoon. But the losses were seen as moderate, and analysts said stable German inflation and the likelihood that rates would not rise for some time would support prices in coming weeks.