Fresh evidence of economic weakness in Germany is now expected to lead to an early reduction in interest rates by the European Central Bank (ECB), possibly as early as its next council meeting on April 8th. A sharp fall in German business confidence yesterday provides the central bankers with a strong argument for a rate cut, as Europe's biggest economy remains stalled.
But despite the latest evidence of Germany's economic difficulties, the council declined to take any action at its fortnightly meeting yesterday, leaving interest rates in the euro zone unchanged.
Cutting rates so close to the resignation of former German finance minister, Mr Oskar Lafontaine, would have been seen by many as provocative.
However, Dr Dan McLaughlin, chief economist at ABN AMRO, said rate cuts could not be guaranteed. He pointed out that the problem for the ECB was that, while manufacturing was very weak, the consumer was still spending on the back of low inflation and interest rates and remained buoyant. "The problem is how to juggle the two."
He also pointed out that oil prices had risen some 30 per cent since the beginning of the year and almost 40 per cent in euro terms. "That will feed through to headline inflation if it is sustained," he noted.
However, the ECB may choose to focus on the euro and the boost which German and other continental companies need if recession and deflation are to be avoided.
The euro closed at $1.0970 in late trade from $1.1016 on Wednesday and at 67.35p from 67.53p.
The Munich-based Ifo economics institute's business climate index in February showed confidence in western Germany falling to its lowest level for 18 months, dashing hopes that an upturn in the euro zone's largest economy might be imminent.
Germany, which accounts for one-third of the economic output of the euro zone, saw production fall by almost 2 per cent in the last quarter of 1998.
Yesterday's Ifo report may not reflect the relief felt by many German businesses following the resignation last week of Mr Lafontaine as finance minister. But the institute said that some of the questionnaires sent to businesses were not returned until after the resignation.
Mr Lafontaine's frequent demands for a cut in interest rates have been identified as one of the chief reasons why rates have still not been cut. The ECB does not wish to be seen to bow to political pressure, particularly in view of the fall in the euro's value since its launch three months ago.
The appointment of Mr Hans Eichel as Finance Minister in Bonn is widely seen as helpful to the cause of reducing interest rates. A softspoken, somewhat colourless figure, he is likely to adopt a more conciliatory approach to the ECB.
Mr Lafontaine formally left office yesterday, paying tribute to colleagues but refusing to discuss the events that led to his resignation.
