Commentary: Backed up by the Bundesbank

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The Independent Online
Any hopes that the French franc would enjoy a period of new year grace before speculators returned to the attack have been swiftly dispelled. The Bundesbank and Bank of France were forced to buy francs on Monday as the currency fell towards its floor in the exchange rate mechanism. Yesterday they issued a joint statement pledging defence of its existing parity. More impressively, the Bank of France matched words with action and raised official interest rates.

They are to be applauded for acting before the drama becomes a crisis - in contrast to Britain's refusal to contemplate interest rate increases in the run-up to Black Wednesday. The franc had a relatively easy day yesterday, but their actions still look like stop-gap measures. Only one thing offers a lasting hope of peace in the ERM - a cut in German interest rates with the promise of more to come.

Although it is acting in a less cack- handed fashion, the Bank of France may eventually face the same perverse reaction to interest rate increases as the Bank of England did on 16 September. More than one person in 10 in France is unemployed, industrial output has fallen in recent months and growth this year is likely to be well below its potential rate. The markets thus know that France cannot raise rates much higher without the recessionary spillover becoming unacceptable. High rates then become more a liability to the currency than an asset to be deployed in its defence. Political uncertainty in the run-up to March's national assembly elections will only intensify the pressure.

So will the Bundesbank come to the rescue? There was nothing in its repo operations yesterday to suggest that salvation is in sight. Lower market rates were not used as an excuse to push the repo rate below its previous 8.75 per cent, although the amount of liquidity supplied to the market was slightly more generous than expected. If - as Frankfurt observers expect - the Bundesbank leaves rates unchanged at Thursday's council meeting, the speculators may quickly return to the fray.

The main obstacles to a cut in German rates are the uncertain outcomes of public sector wage negotiations and debates on the supplementary budget. These suggest that an easing will have to wait at least until late next month. But the Bundesbank is much more committed to defending the franc's place in the ERM than it was to supporting the pound. It will engage wholeheartedly in further intervention and - if no alternative remains - it may eventually make excuses and capitulate on rates.