Germany keeps key rate intact Policy could imperil European union

July 30, 1993|By New York Times News Service

BONN, Germany -- The foundations of European monetary union, which France and Germany had hoped to build by the end of the century, seemed gravely threatened yesterday after Germany's central bank decided that defending the mark from German inflation was more important than lowering interest rates to help ease the recession in France.

Although defending the mark against inflation has long been the Bundesbank's main concern, expectations in France and elsewhere were that the political importance of the French-German alliance would outweigh parochial concerns about whether German inflation rose a fraction or not.

That had led to widespread anticipation for more than a week in the United States and Europe that the German central bank would lower its discount rate. Stock traders in Frankfurt and currency speculators in London and New York all hung on the bank's decision, which came late in the day in Bonn. In the end, it left the rate unchanged, at 6.75 percent.

Instead, with little public comment and no news conference after yesterday's meeting -- its last before a monthlong vacation -- the bank's central council announced only that its Lombard rate, which acts like a ceiling on German money-market rates, would be lowered to 7.75 percent, from 8.25 percent

But this was like throwing a dry bone into a frenzy of speculation against the franc on the currency markets, which in late trading ++ yesterday in New York was at 3.4237 francs to the mark, sinking near its established floor of 3.4305 to the mark, in Europe's grid of exchange rates. That was off from 3.404 francs to the mark before the Bundesbank's announcement.

The weakening franc prompted the Bank of France to buy francs and sell marks to prop up the French currency with the aid of other central banks.

Gold prices soared above $400 an ounce Wednesday for the first time in about three years as concerns that the European Monetary System might collapse sent investors rushing to precious metals.

The German discount rate is critical because it sets a floor on short-term interest rates in Germany and other countries like France whose currencies are tied to the mark.

Despite reductions that have brought the discount rate down over the last year, the Bundesbank has been reluctant to cut it faster because of a wave of inflation set off by government and private borrowing to finance the soaring costs of German unification in 1990.

But now, "The odds of a European exchange rate mechanism realignment or collapse have risen sharply," said Kermit L. Schoenholtz, chief analyst for Salomon Bros. International in London.

The advice of the analysts was, in effect, that clients should sell francs and other European currencies tied to the mark and hold marks or other currencies instead.

If investors push a sell-off of francs today, the Bundesbank, which has bought billions of francs in recent weeks to try to shore up the French currency, is expected to join the Bank of France in doing so again.

But if the selling continues because traders think the French will be forced to devalue anyway, they may have to accept either a devaluation of the franc against the mark or suspend the franc temporarily from the European monetary system. The system, a network of linked currencies, was designed to be the forerunner to a single currency by 2000.

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