Commentary: Bundesbank helps to tilt the scales

The battle between the French and German monetary authorities and the foreign exchange markets continued to rage yesterday. Amid the smoke, gunfire and confusion, the conflict seemed marginally to be tilting in the direction of the Banque de France and the Bundesbank. Despite rumours that the French had exhausted their never large foreign currency reserves, the franc stayed within its exchange rate mechanism bands.

The most significant reason was the joint declaration of the finance ministries and central banks (including the Bundesbank) that 'the current central rates between the currencies correctly reflect the real situation of their economies and . . . no change in the central rates is justified'. This is strong stuff. The Bundesbank has put its reputation on the line, and it has the power to supply the markets with as many marks as are needed to hold the mark down against the franc. Ask any monopolist: if you control the supply, you control the price.

During the day, the Bundesbank also intervened before the franc had hit its floor, an unusual sign of commitment which suggests that some of its intervention may have been on its own account (building up German reserves of French francs) although it is also foreseen in the Basle-Nyborg agreement on unlimited credit. The third signal was German money market rates. Three month interest rates eased nearly half a point to 8 per cent, and overnight money rates crashed as low as 2 per cent before settling between 4 and 6 per cent.

There are two interpretations of what was going on: the first is that the Bundesbank has decided not to mop up all the marks being deposited on the Frankfurt money markets when speculators sell their francs. In other words, the German central bank will print the money to hold the rate even if it means, say, a boost to money supply growth of 4 per cent. The other interpretation is that the scale of intervention is now so huge that the Buba's money market operations have been unable to keep up.

Anybody now speculating against the franc must bear in mind the possibility that the Bundesbank is prepared to sacrifice, at least temporarily, its domestic money supply objectives. There is a precedent: in 1978, the Germans intervened heavily to support the dollar, and allowed the money supply to expand by more than 20 per cent. It is not a period that Frankfurt policy-makers much admire, but they may argue that France and the franc are worth fighting for. After all, France's fundamentals are extraordinary. If you looked purely at the economic numbers of the two countries, it would be the French scoring lower inflation and improving competitiveness.