Defence of pound may have cost dollars 30bn

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The Independent Online
(First Edition)

Last month's unsuccessful defence of the pound may have cost as much as dollars 30bn, official British and German figures suggested yesterday.

As the figures emerged, the pound plunged on the foreign exchanges with concern mounting over the continued absence of a coherent economic strategy. Some in the market also attributed the pound's decline to Norman Lamont's refusal to resign as Chancellor.

Sterling sank by more than 5 pfennigs at one stage yesterday, before closing 4.66 pfennigs down at a record low of DM2.4352. Since the start of the week, the pound has slumped by 10 pfennigs.

The estimated dollars 30bn slump in UK official reserves is unlikely to show up in official figures for months to come. The Treasury yesterday issued official figures for Britain's foreign currency reserves, which showed an underlying fall of dollars 7.69bn to dollars 42.67bn. This included foreign currency borrowings last month of dollars 6.055bn.

But the greater cost in defending the pound was not revealed in these figures. This is represented by by loans from the Bundesbank, which will have to be repaid and will deplete the reserves in future months.

Earlier this week, the Bundesbank stated that it spent 'the greater part' of DM44bn in helping to defend the pound. Yesterday, Helmut Schlesinger, Bundesbank president, revealed that since the beginning of September, when the European currency crisis broke out, overall currency intervention by the German central bank totalled DM92bn.

Of the DM44bn (dollars 31bn) provided by the German central bank in the week of 'Black Wednesday', part of which was used in defence of the Italian lira, around DM33bn (dollars 23bn) is thought to have been lent to the Bank of England through the European Monetary System's very short term financing facility.

Under this arrangement, the Government will be obliged to repay most of the loan within three months, and the balance in a further three months, according to EMS rules. But with the agreement of the Bundesbank, the Bank of England could roll over an additional amount for a further three months. The estimated dollars 30bn depletion of UK reserves may not therefore show up until next June at the latest.

In addition to loans from the Bundesbank, the Bank of England could have bought pounds for marks in the forward foreign exchange market, and the impact on the reserves will not show up for several months.

However, the ultimate cost to the British Government will have been a fraction of that figure, and depends upon the extent to which the pound has depreciated against the Bank of England's reserves of marks. Much of the Bundesbank loan is likely to have been made at the pound's former floor in the exchange rate mechanism of DM2.78, and the Bank will incur a loss when it is repaid. But some of the Bank of England's reserves of marks were bought in 1988, at DM2.99 to the pound, and the Bank will have made a profit when it sold these marks for pounds.

An additional consequence of the huge contraction in reserves is a large reduction in the Government's funding needs for financing the public sector borrowing requirement. This reflects the large flow of pounds into government coffers.

In the financial markets, there was widespread gloom at the extent to which the reserves seem to have shrunk.

If the estimates of the contraction prove correct, they imply that Britain has insufficent funds to cover the annual current account deficit, which analysts estimate at about pounds 12bn for 1992.

Though a payments deficit is normally of little concern, the falling pound reflects a collapse in foreign confidence in sterling, and suggests that foreign inflows, which are the normal method of financing the deficit, may be drying up.

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