Central banks stepped into the currency markets to prop up the dollar yesterday. Aggressive intervention by the Federal Reserve, Bank of Japan and Bundesbank, among others, helped the currency reverse direction.
The substantial purchases of dollars by the central banks - estimated at up to $2bn - took foreign exchange markets by surprise. After the dollar's steep fall at the end of last week many dealers had "short" positions, having sold dollars they had not yet bought. The intervention was a sharp reminder to traders that currencies can go up as well as down.
Robert Rubin, the US Treasury Secretary, said the US would continue to co-operate with other countries in line with the Group of Seven's objective of reversing some of the dollar's startling decline against the yen and Deutschmark this year.
Neil Mackinnon, chief currency strategist at Citibank, said: "This is a message to the markets that central bank intervention is alive and kicking ahead of the G7 summit." The summit of heads of state and finance ministers will be in Halifax, Nova Scotia, on 15-17 June.
However, analysts said yesterday's action had only a limited effect. The dollar rose by 3 pfennigs and just over 2 yen, taking it above DM1.41 and, briefly, 85. Julian Jessop, an international economist at HSBC Markets, said: "The exchange rate has not really moved all that much. It would have been more effective if the dollar had already started moving of its own accord." Citibank's Mr Mackinnon added that any central bank intervention would be unsuccessful unless followed by changes in interest rates.
The currency markets are hanging on the outcome of today's meeting of the Bundesbank Council. Many analysts think there is a chance of a cut in German interest rates, although Richard Reid at UBS in Frankfurt doubted the Bundesbank would cut rates again soon.
The prospect of higher US interest rates retreated yesterday following figures that showed gross domestic product growth in the first quarter was slightly lower than originally estimated. The annual growth rate was revised to 2.7 per cent, following 5.1 per cent in the final quarter of 1994.
The dollar's gains yesterday helped the pound. It climbed to DM2.2530, nearly three pfennigs higher than the previous close. The effective exchange rate index rose to 84.3. The pound rose slightly against the dollar to $1.5888. Traders said the Bank of England had also intervened to support the dollar.