Demise of 'Red Oskar' delights central bank

Officials of the European Central Bank (ECB) will have breathed a sigh of relief at the resignation of the German finance minister, Oskar Lafontaine. As the news spread, the euro, Europe's fledgling single currency, rallied too.

It was not just that Mr Lafontaine was one of the severest and most persistent critics of the new central bank, engaging in damaging bouts of megaphone diplomacy with the bank and its leader, the Dutchman Wim Duisenberg.

Mr Lafontaine's constant calls for the ECB to cut interest rates had dragged down the euro: since its debut on the foreign exchange markets on January 4, the single currency has lost around 10 per cent of its value against the dollar.

The fall spelled double trouble. There was disquiet from the German electorate who had been told the euro was a strong currency, able to hold its own against the dollar.

In addition, there was growing anger in the United States that Europe was not doing enough to promote world growth.

In recent days tensions between the ECB and Mr Lafontaine and his deputy, Heiner Flassbeck, had reached such a pitch that the Bundesbank - once the arbiter of Europe's interest rates - felt compelled to intervene.

Council members from the Bundesbank let it be known that they felt Mr Lafontaine was behaving unprofessionally and its president, Hans Tietmeyer, even suggested that Mr Lafontaine's assaults were counterproductive.

"The more intensely these discussions are led in public, the less scope there is for [lower interest rates]," he said.

His words may prove prophetic. "Red Oskar's gone, the euro's up," one currency analyst said last night as the single currency, which had fallen from a launch level of near $1.18 to a low of $1.08, was last night trading at above $1.10 (68p).

Ironically Mr Lafontaine's resignation could pave the way for the very policy he had advocated.

Though he had insisted interest rates needed to be lowered from the current 3 per cent to boost the German
economy, it was widely thought that the ECB was hamstrung by the weakness of the new single currency.

Now Mr Lafontaine has gone, the arrival of a less abrasive replacement could give the ECB room for manoeuvre to cut borrowing costs.

Last night Europe's money markets were already placing bets on a rate cut, certainly before the summer and perhaps even earlier. The ECB council, which sets interest rates, meets again next week.

Business and the financial markets may have other cause to celebrate Mr Lafontaine's passing, not least London's lucrative eurobond market.

Mr Lafontaine was a keen advocate of tax harmonisation in the European Union and was pushing for a flat rate withholding tax on offshore investments - a move which could have driven the trade in eurobonds out of the City of London.

His departure will please Germany's business establishment, too. Mr Lafontaine was pushing through tax changes which big industry, especialy insurance and energy firms, claimed would cost billions. Allianz, one of Europe's biggest insurance companies, has already threatened to move work abroad. Other firms have told workers not to expect a pay rise because of the extra tax burden - a stance which led to strikes yesterday.

But the resignation is not unalloyed good news for the financial markets. Mr Lafontaine was close to his French counterpart Dominique Strauss-Kahn and his departure may lead to growing tension between Bonn and Paris.

As the Franco-German alliance is seen as essential for the stability of the euro, any cracks in the relationship are viewed with nervousness.

A cooling in Franco-German relations may please the foreign exchange dealers, for whom every row is a trading opportunity, but it may scare those who invest in government bonds.

Mr Lafontaine may still be missed - but not yet and not sorely.