Breathing space for the pound: Threat hangs over sterling despite German pledge as Europe's policy-makers face tough two weeks

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The embattled pound is likely to receive a boost this morning from the weekend announcement that Germany will not raise interest rates for the time being.

Though a threat still hangs over the currency, the European finance ministers' meeting in Bath may have bought a breathing space. With support reviving in France for the Maastricht treaty, the situation on financial markets should ease slightly.

However, the French referendum on European union is not until 20 September, and European policy-makers are going to have a tough fortnight. The Bank of England and the Treasury were very nervous yesterday over how the Bath meeting's conclusions would be received.

City economists gave a guardedly positive reaction and predicted it would somewhat reduce the strains now racking the exchange rate mechanism (ERM).

The meeting wrung a concession from the German central bank after fierce arguments. Norman Lamont, the Chancellor, said on Saturday: 'The Bundesbank in present circumstances has no intention to increase rates and is watching closely the further development in the economy. It is the first time that this has been said publicly in this way.'

The ministers took a firm stance against devaluation, which is expected to give some relief to the pound. Most attention will focus on the lira. A fresh attack on the currency forced Italy's central bank to lift its discount rate to 15 per cent and start to draw on the short-term financing facilities of the ERM. But, with US markets closed today for the Labor Day holiday, fears that further funds could flow out of the dollar to the German mark will not be fully tested until tomorrow.

The large disparity between the recent direction of interest rates in the US and in Germany is at the heart of the crisis. As the market switches into the mark, still regarded as the hardest ERM currency, it strains links between the mark and fellow ERM currencies.

According to reports from Tokyo, officials from the Group of Seven top industrial nations are working on a communique for release in Washington on 19 September - the day before the French referendum - aimed at curbing the mark's rise.

A sliding dollar, provoked by worse-than-expected US employment data and a move by the Federal Reserve Board to cut its Fed funds rate by 0.25 points to 3 per cent undid most of the progress made by the pound on Thursday when the Chancellor announced a 10bn ecu ( pounds 7.3bn) loan to support the currency. Because of the dollar's renewed decline, sterling ended the week at DM2.80, 2 pfennigs above its ERM floor. Analysts said the strong tone of the finance ministers' informal statement, which promised to buttress ERM currencies with every means, would help sterling to recover ground lost on Friday.

David Simmonds, of Midland Montagu, thought the show of concerted unity among European finance ministers would 'take the steam out of the situation'.

He added: 'Sterling is going to hold up. On Friday it was caught up in the backwash of a run out of the dollar. There was no sign of independent pressure on the pound.' But Gavyn Davies, Chief UK economist at Goldman Sachs, warns in today's Independent that 'the British government's intervention tactics will work at best for only a short period'.

Further turmoil in the European Monetary System would provoke not just a financial but a political crisis. In Britain, as in many EC countries, opposition to Maastricht and to the European integration is balanced on a knife-edge.

Surveys show a majority of French voters who have made up their minds - 56 per cent, according to a poll in the Journal de Dimanche yesterday - back Maastricht. Last week's television appearance by President Francois Mitterrand has given the 'vote yes' campaign new momentum.

The Prime Minister will flag the political way forward for the EC when he opens a London conference on 'Europe and the World after 1992' this morning.

He is expected to say that while Maastricht remains the best way forward, a de facto French referendum veto would not alter his priorities of greater decentralisation of Brussels power, membership enlargement, and completion of the single market.