Bundesbank Surprises with Cut in Rates

In a surprise but welcome move, Germany’s central bank Thursday lowered the cost of borrowing and hinted that more reductions may be needed to help revive Europe’s largest economy.

The Bundesbank, usually one of the world’s most cautious central banks, trimmed two key interest rates by half a percentage point each, to historic lows.

The central banks of Austria and Belgium lowered rates in response, a sign of Germany’s economic influence in Europe. Expectations were widespread that France’s central bank will lower rates soon.

The Bundesbank has tended to view lower rates as a stimulant to inflation, historically considered a nemesis in Germany. But economists said the central bank felt compelled to reduce rates in order to encourage German businesses and consumers to borrow and spend more money.

The Lombard rate, the rate at which banks borrow emergency overnight funds from the central bank, was lowered to 4.5% from 5%. The discount rate, the cheapest form of central bank refinancing, fell to 2.5% from 3%. The rates were last reduced Dec. 14.

At a news conference after the cuts were announced, Bundesbank Chairman Hans Tietmeyer said they were a “signal that no increase in interest rates was intended for the foreseeable future.” In fact, he said, “We will tend to explore room to move rates lower rather than higher.”

The rate cuts won quick praise from government and other key officials, including Economics Minister Guenter Rexrodt and Finance Minister Theo Waigel.

Bundesbank officials said the rate cuts were possible because of low inflation and a continued steady price-trend outlook. Annualized inflation in March was 1.7%, up slightly from 1.6% in February.

The cuts recast growing speculation that the Bundesbank would eventually be forced to reduce rates to stimulate the German economy, where unemployment has hit record levels.

But in recent days skepticism about a rate cut also had grown, partly because of evidence that Germany’s money supply is rapidly increasing.

The Bundesbank scrutinizes the money supply as a barometer of inflation.

Otmar Issing, a member of the Bundesbank’s board, said the rate cuts were “necessary from our point of view ... to help the real economy within our limits.”

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A comparison of major central bank rates. D7