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Buba cut may

further weaken

FRANKFURT: Thursday's half-point cut in official German interest rates, which the Bundesbank said was mainly aimed at boosting a contracting money supply, may initially prove counterproductive, economists said.

The cut in the discount and Lombard rates, to 3.50 percent and 5.50 percent respectively, will encourage investors to shift funds to higher-yielding, longer-maturity investments which are not included in the M3 aggregate, they said.

That process, known as money capital formation, would depress M3 and contribute to keeping it well below the Bundesbank's 1995 target growth range of four to six percent.

Meanwhile it would take months before the move to cheapen credit will begin to have its intended effect of stimulating the money supply by boosting bank lending, economists said.

"What the Bundesbank is gambling on is that by cutting rates it can induce credit expansion and that this will outstrip money capital formation," Andrew Bosomworth, an economist at Merrill Lynch in Frankfurt, said.

"But it's a big gamble and I'm not not convinced they are going to win on it."

Ulrich Beckmann, an economist at Deutsche Bank Research, said, "It could be that the money supply slows further in the short run as a result of the interest rate cut."

Beckmann added that the rate cut would boost lending eventually, but that this would not affect M3 until the end of the year at the earliest.

"M3 growth will clearly miss its target and will be about one to two percent this year," Beckmann said.

Lothar Hessler, an economist at Trinkaus & Burkhardt, said, "The rate cut will tend to cause a rise in money capital formation in the coming months. It has become even less likely that M3 will reach the target corridor."

German bonds remain attractive to investors even though 10-year bond yields have already fallen by almost one point this year and many economists see Thursday's rate cut as the last in the current cycle.

"Market participants see current bond yields as attractive against the background of falling inflation and the weak economic situation," Uwe Angenendt, an economist at BHF-Bank in Frankfurt said.

Bundesbank chief economist Otmar Issing said on Thursday that the 0.4 percent annualised contraction in German M3 money supply in July was the trigger for the rate cut.

Ironically, the Bundesbank in May 1994 cut interest rates for the opposite reason, to put a brake on money supply growth by fostering investment in long-term funds.

At the time, though, M3 had been bloated by investors parking funds in deposits to avoid the volatility wracking financial markets.-Reuter