Higher German Interest Rate to Bolster Mark and Curb Domestic Inflation

DESPITE international and domestic warnings that interest rates here are getting dangerously high, the German central bank yesterday demonstrated its independence and kicked rates up to their highest level in more than a decade.The move shows that the Bundesbank is unwilling to waver from its chief goals of low inflation and a strong deutsche mark. Painful as it may be, a tight monetary policy is the only way to achieve these goals at the moment, the Bundesbank decision implied. In their first meeting under the new Bundesbank president, Helmut Schlesinger, the bank's council voted to increase the discount rate (the rate at which it lends to banks) from 6.5 percent to 7.5 percent. It slightly increased the Lombard rate (its short-term, emergency lending rate to banks) from 9 percent to 9.25 percent. The last time rates were this high was in 1980. Paul Horne, international economist for Smith Barney, Harris Upham & Co. in Paris, said the move was expected and "reinforces the bank's reputation as chief defender of price stability." Just two days before the Bundesbank meeting, German Economics Minister Jurgen Mollemann issued a strong warning that a rise in interest rates could snuff out flickering economic renewal in east Germany, because borrowing money to invest in new companies there would simply become too expensive. An interest rate rise will "seriously injure the delicate first shoots of recovery in eastern Germany," Mr. Mollemann said. His concerns were echoed by the Association of German Banks, which issued a statement earlier this week opposing a rate increase. The Bundesbank has also been under international pressure from European Community members and the United States to keep rates steady, or even lower them. Several key members of the EC, such as France and Britain, are struggling with recessions and are in fact trying to lower their interest rates to stimulate economic growth. But because most currencies in the EC are linked to the deutsche mark, any move by the Bundesbank to raise rates in Germany puts enormous pressure on the other countries to do the same - or risk devaluation of their currencies. So far, Britain has defied a January rise in German interest rates by lowering its rates anyway. The United States, also in a recession, has done the same. France, on the other hand, has not considered itself able to lower its rates. Mr. Horne says, however, that since the Germans only slightly adjusted the Lombard rate - the rate which most affects international markets - yesterday's decision should not spark great concern outside of Germany. The Bundesbank says that, in the long term, the best thing for its trading partners is a finely tuned German economic engine that purrs along at a low rate of inflation and with a strong deutsche mark to back it. Inflation, by German standards, has certainly reached uncomfortable highs. It is now at 4.4 percent, compared with 2.7 percent last year. This has been brought on by labor-union wage increases of 7 percent, strong consumer buying in eastern Germany, and a tax increase to pay for unification, intended to be in effect only one year. By raising interest rates, the central bank wants to send a message to union negotiators to hold back on salaries. But it also is signaling the federal government to make some serious budget cuts instead of paying for unification almost solely through tax increases and borrowing. Markets, apparently, have already anticipated the Bundesbank's move. Over the last few weeks, the dollar has weakened, while the mark has been gaining strength.