Germany: The Bundesbank's Hands Are Tied

Germany's "phase of pronounced weakness," as the Bundesbank puts it, looks more like a plain old recession. The economy is on the verge of back-to-back quarterly declines in real gross domestic product. But even with unemployment at a record high and inflation near a record low, the Buba has put interest-rate cutting on hold. That threatens to prolong the suffering.

The problem is unruly growth in the M3 money supply and a backup in long-term interest rates. M3, which the Buba views as a key gauge of future inflation, surged in February at an annual rate of 12.6% from the fourth-quarter level. The pace was far above the 4%-to-7% target, and it pushed bond yields even higher. Although special factors, including heavy government borrowing, are exaggerating M3's pace, the speedup dashes hopes for a rate cut soon. The official discount rate has been at 3% since Dec. 14. Analysts now believe that a cut is not possible until May or June.

Aside from some modest tax relief, fiscal policy offers no help. On Mar. 15, Finance Minister Theo Waigel imposed a federal spending freeze on big-ticket items aimed at preventing this year's deficit from overshooting the planned 60 billion marks ($40.7 billion) target. And on Mar. 19, Chancellor Helmut Kohl projected that "massive" cuts in public spending will be needed next year to meet the Maastricht goal.

GERMANY: THE BUNDESBANK'S HANDS ARE TIED

Meanwhile, last year's inventory pileup continues to depress manufacturing: Orders weakened further in January from an already-low December level. The drop in business confidence is unabated, with the February reading the lowest in two years (chart). The severe winter is compounding the first-quarter weakness, hitting construction especially hard, so some weather-related rebound in the second quarter seems likely.

That may further cloud the Buba's reading of the economy. However, with inflation at a 5 1/2-year low of 1.4%, further manufacturing weakness would probably override the central bank's M3 worries and allow a rate cut.

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