Cancel interest rate increase, German industry pleads

By Ambrose Evans-Pritchard
The Telegraph, London
Thursday, August 23, 2007

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/08/23/cnecb1...

German industry has appealed to the European Central Bank to cancel a rise in interest rates next month, warning that the credit crunch risks triggering a worldwide economic downturn.

The powerful German Chamber of Industry and Commerce (DIHK) said banks had abruptly tightened lending standards and sharply raised the cost of borrowing for smaller companies.

"What we are seeing in the credit markets is likely to have a major effect, damping economic dynamism in coming months, not just in Germany but across the world," said Axel Nitschke, the group's chief economist.

advertisement"In this climate, I would plead with the ECB not to raise rates in September," he said, citing a marked slowdown in M3 money growth. The DIHK said it had begun receiving distress calls from Mittelstand family firms as long ago as June, complaining that credit was drying up.

Adding to worries, Germany's ZEW indicator of financial confidence plunged from + 6.9 in July to -10.4 in August, the lowest this year.

Two German banks have run into severe trouble on US sub prime mortgage loans and collateralized debt obligations (CDOs). Berlin has orchestrated a taxpayer bailout, guaranteeing debts of E17.3 billion for Sachsen LB and E8.1 billion for IKB -- in both cases to cover wild investments through off-balance sheet "conduits" in Ireland.

Alexander Stuhlmann, chief executive of WestLB, rattled markets on Tuesday with a blunt warning that the German banking system faced "huge problems" and was in a "not uncritical situation."

"If we have a bank crisis in Germany that cuts us off from foreign finance, then our financial institutions could get into further difficulties," he said, saying the sub-prime debacle had caused "reputational damage" for the state-owned Landesbanken that was likely to linger. German banks hold some E727 billion in credits from foreign sources, according to the Bundesbank.

Earlier this month, Jean-Claude Trichet, the ECB's president, signalled a quarter-point rate rise in September to 4.25 percent by invoking the code term "strong vigilance," but that was before credit seizure prompted a massive injection of ECB liquidity. The bank issued a statement yesterday insisting that it was sticking to its schedule.

Holger Schmieding, Europe economist at Bank of America, said the eurozone was strong enough to weather the current storm, but only if the ECB draws a halt after the next rate rise. "What the markets need is certainty. The ECB must make it clear that there will be nothing beyond September," he said.

Mr Trichet has already clashed openly with French president Nicolas Sarkozy over monetary tightening, which has caused France's property boom to stall. Paris holds the ECB responsible for the super-strong euro, now trading at over $1.35 to the US dollar.

Mr Sarkozy has succeeded in axing key clauses in the draft EU treaty that safeguard the ECB's independence and has been casting about for allies to enable him to invoke Maastricht treaty article 109-4, giving politicians the final say over the euro's exchange rate.

Finance minister, Christine Lagarde, left no doubt yesterday that Paris wants an immediate halt to rate rises. "It would certainly help enterprises. It would also help the markets at the moment," she said.

Axel Weber, the head of Germany's Bundesbank and the most vociferous ECB hawk, has given a series of interviews in a recent days stressing the risks of inflation, but it remains unclear whether the hardliners could muster a majority for further tightening.

The swing voter is likely to be Italy's Mario Draghi, a former managing director of Goldman Sachs and president of the BIS's Financial Stability Forum. He has not tipped his hand.

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