Central banks see off speculators

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THE FRENCH franc yesterday staged a convincing recovery from one of the gravest speculative attacks since the Second World War, as the impression grew that the central banks may have finally gained the upper hand over the markets.

Though the currency turmoil that broke out in earnest two weeks ago may yet resume, few in the market are presently willing to bet on a French franc devaluation. Aided by further intervention from the Banque de France shored up by rumoured support from the Bundesbank, the franc recovered from a low of FFr3.40 to the German mark yesterday to around FFr3.3775, the highest level for six weeks and safely above the European exchange rate floor of FFr3.4305.

'The crisis may not be over,' said George Magnus of Warburg Securities, 'but the battle is now moving in favour of the central banks.'

The French central bank was thought to have all but exhausted its foreign currency reserves and was rumoured to have sold gold to buttress its intervention on the foreign exchanges.

The franc's recovery was also said to have been helped by the covert assistance of French commercial banks, which quoted wider than usual spreads for trades in French bonds, making it more costly for speculators to sell French government paper.

The franc's recovery was heightened by rumours that the exchange rate mechanism could be realigned this weekend, with the hard currency core comprising the mark, the French franc, the Belgian franc and the Dutch guilder revaluing against the Spanish peseta, the Portuguese escudo and the Irish punt. As a result, few dealers felt safe starting the weekend with oversold positions in the French franc.

The pound meanwhile weakened early in the day, falling around two and a half pfennigs to DM2.51 as concern mounted that John Major's speech to Parliament on Thursday had failed to reassure the markets that the Government has a coherent economic policy. But in late trading, the pound ended less than a pfennig lower at DM2.7371, aided by short covering ahead of the weekend and rumours that sterling would return to the ERM, which the Treasury denied.

Whether turmoil returns to the markets depends upon market reaction to Monday's meeting of European finance ministers in Brussels, at which reforms of the European Monetary System are due to be discussed. However, expectations that reforms will be discussed in detail are probably overdone.

Markets are also likely to react to next Friday's Bundesbank council, where some hope to see a further cut in official German interest rates. Yet here, too, hopes may be riding too high.

Bundesbank officials this week expressed growing concern at the acceleration of money supply growth, which they put down almost entirely to the continued expansion of credit demand. The Bundesbank's massive sales of marks in the foreign exchange markets, put at well above DM60bn, have yet to feed through to the official money supply figures. Although the Bundesbank has moved to sterilise the impact on the money supply by selling German government bills and bonds, it is thought the Bundesbank's intervention may drive German money supply growth even higher.

The dollar was briefly lifted by the continued uncertainty surrounding the ERM in spite of weak US economic figures. US durable goods, excluding orders for military equipment, fell by 0.9 per cent in August. Existing home sales dropped by 3.2 per cent.

By the London close, however, the US currency was nearly one pfennig lower at DM1.4785 while the pound gained 0.5 cents to dollars 1.7135.

Meanwhile, concern about Democratic Presidential candidate Bill Clinton's plans for controls on healthcare costs sparked a sale of drugs stocks on Wall Street. After diving to 3,233.84, the Dow Jones average closed 37.55 points down at 3,250.32.

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