The Bundesbank's Balancing Actby
The Bundesbank should feel pleased. The central bank has fostered a sound economic recovery and lowered inflation while reining in money growth and keeping the mark rock-solid. Now comes the tricky part: holding it all together.
After keeping a steady hand on policy since July, the Buba is now caught between a surging mark and a decaying inflation outlook. Recent wage settlements, which are raising inflation fears because they will double wage growth to 4%, argue for higher rates. But exporters and politicians are clamoring for an interest rate cut, worried that the mighty mark will thwart the export-led recovery.
Despite hints of a rate cut by Bundesbank President Hans Tietmeyer--who likely meant to jawbone the mark lower--the next rate move looks to be up. The mark's muscle will hamper growth, but it's not yet a threat to the recovery. Any export slowdown will come gradually, given strong demand in Europe and eastern Germany, especially for capital goods. Firmer domestic demand will take up some slack, as business investment and consumer spending make a bigger contribution. The economy grew 2.4% in 1994, finishing with a surge in demand, and analysts expect about 3% this year.
While the higher mark may temporarily lower the cost of imported materials, the more-than-offsetting inflationary jolt from faster wage growth will last. Wage gains and a productivity slowdown from '94's record pace will lift unit labor costs. Also, fiscal policy will turn stimulative in '96. February producer price inflation, although tame at 1.8%, hit a three-year high. March consumer inflation, at 2.4%, remains above the bank's 2% target.
The Bundesbank would ease policy only in a full-blown currency crisis, such as a plunge in the French franc if Prime Minister Edouard Balladur loses the May presidential election. But given the strong mark, plus below-target growth in the key M3 money supply, the Buba can at least delay what appears to be an inevitable tightening.