Warning that EMU will force cuts in high interest rates

Date: 05/03/1998

EUROPE's monetary union should kick off next year with the same low interest rates now operating in France and Germany, insists a member of the Bundesbank's policy-making council.

Klaus-Dieter Kuebacher, president of the Berlin and Brandenburg state central bank, believes short-term interest rates among euro-qualifiers should 'converge' around 3.3&percent; rather than rise to 4&percent;.

If his argument is accepted by Bundesbank colleagues and the Bank of France, then Ireland and southern member states will be forced to cut their interest rates sharply in the nine months before EMU starts. The cost of short-term borrowing now stands at 4.5&percent; in Spain, 5.5&percent; in Italy and 6.75&percent; in Ireland.

“Every week, we look at the forward rates and they say that in nine or ten months' time rates will be 4&percent;,” Kuebacher told European Voice late last week.

“I say that German, French and Dutch interest rates of 3.3&percent; are the bench-mark and I don't see the central banks putting them up at this stage.

So rates in Italy, Spain, Portugal and Ireland will have to come down in large steps or they will have a shock on 1 January 1999 when we will have the same rate all over Europe.”

Kuebacher believes the impact of the Asian financial crisis, the prospect of Iraq being allowed to sell oil on to the world market and continued high unemployment depressing wage settlements in Europe should all keep inflation under control.

“I am speaking from the point of view of a German central banker, but I can see no reason to put our interest rates up this year. In fact, we now have conditions where we could even consider reducing them. If it were not for the value added tax rise, our inflation rate would be heading below 1&percent;,” he said, referring to the planned increase in German VAT from 1 April.

For some countries, however, cutting interest rates while keeping their currency stable at the rate they wish to join EMU and capping inflationary pressures could be difficult.

Central Bank of Ireland Governor Maurice O'Connell admitted last month that he would have liked to keep interest rates higher to cope with booming domestic demand. Only the prospect of joining EMU in January was obliging him to ease monetary policy.

Kuebacher insists that he will not vote for interest rate increases to meet the high-rate countries halfway because of his worries about the fragility of Germany's economic recovery.

“It is different in Germany. We must not increase interest rates, not only for economic but also for psychological reasons,” he said.

“It would hit investment. We keep reading that German industry is thinking about expanding investment and, if we even signal slightly that we are on an upward interest rate trend, then these intentions for investment could be stifled. I couldn't want this when I look at the kind of unemployment we have.”