Sir Leon Brittan, the EC commissioner responsible for external economic affairs, said yesterday that the ERM would have to operate more flexibly and that realignments of the system's currencies needed to be better timed.
The cuts in German interest rates eased pressure in the ERM by weakening the mark, although trading remained very nervous.
The Danish krone - which has been under intense speculative pressure this week - rose to close at DKr3.3827 to the mark, above its floor of DKr3.9016. This left the French franc to end the day as the ERM's weakest currency, although it closed more than four centimes above its floor.
David Cocker, of Chemical Bank, said the German move would 'alleviate the pressures for now, but if they do not ease again in the next few weeks the pressures could resurface'. Alison Cottrell, of Midland Global Markets, said the cuts were 'a sticking-plaster job designed to get the ERM through to the French elections - but which may not even achieve that'. She added that even if France were able to follow the Bundesbank's quarter-point interest rate cut, this would do nothing to help the French real economy, which was being crippled by high rates.
Pressure on the franc is expected to intensify in the run-up to the French national assembly elections, which take place on 21 and 28 March.
The Danish krone began the day pinned to its floor in the ERM and under severe pressure. It gained a brief respite from rises in key Danish interest rates and a concerted support-buying operation from the central banks of the ERM's 'hard core'.
The Danish central bank raised its key longer-term deposit and discount rates by two percentage points to 11.5 per cent, following Wednesday's 1.5 point rise in its two-week rate. The Danish, German, Belgian, French and Dutch central banks then joined forces to intervene in the krone's support, but failed to lift it convincingly from the floor.
The Belgian central bank also widened its self-imposed band of variation for the Belgian franc about its mark central rate. The widening from 25 to 30 basis points was evidence that speculative pressures have penetrated to the very heart of the ERM.
Sir Leon said he believed the ERM would function better 'if there was a broad acceptance that the ERM is not a fixed-rate currency system and an understanding that realignments are not a sign of crisis, but do take place from time to time.'
At present countries, for reasons of pride and loyalty to the system, waited 'far too late' before seeking help, committed for reasons of pride and loyalty to the system to maintaining exchange rate parities for as long as possible, Sir Leon said.
'If instead realignments could be considered and looked at at an earlier stage as part of the process of multilateral surveillance, not just when one currency is in crisis, it would be a big step forward,' he suggested.
Gerard Lyons, at DKB International, agreed that the salvation of the ERM required a more flexible system as well as sharp cuts in German interest rates. He said yesterday's cuts had 'reinforced the trend towards a two-speed Europe', with the Bundesbank moving to defend the core. But he added that sharp falls in German rates would probably have to wait until the summer.
Jacques Delors, president of the EC commission, welcomed the German cuts as the political step in the right direction that everyone had been waiting for. 'It should change the mood and send a positive psychological message to the markets,' he said, stressing that the most important thing was to reverse the tendency towards 'the re-nationalisation of economic policy.' He warned Britain: 'Devaluation has immediate short-term advantages, but in a world with no (economic) solidarity the downside becomes obvious straight away and is manifest in a loss of competitiveness and jobs. This is what has happened to one EC member state I shall not name'.
The German rate cuts boosted the pound, which ended 3.27 pfennigs higher at DM2.3910 and a cent stronger against the dollar at dollars 1.4447. But the sharpest leap in the pound took place on morning rumours of buying by the aggressively speculative Malaysian central bank.
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