The sudden resumption of ERM tensions will be one of the main issues for discussion at a meeting tomorrow of the EC Monetary Committee, a secretive group of top central bank and finance ministry officials. But despite market rumours, there are no signs that a realignment of ERM parities, including a revaluation of the mark, is being considered at this stage.
Although central banks are expected to spring to the defence of the two currencies, hopes are riding on the German Bundesbank, which may be obliged to send an early signal that a cut in its leading interest rates is on the way.
The German central bank is widely expected to reduce the securities repurchase rate, currently 7.28 per cent, this week. The markets would take this as a sign that when the Bundesbank central council meets on 29 July, the final session before the summer recess, it will cut the 6.75 per cent discount rate.
Much will depend on whether figures for German money supply growth and inflation due this week and next suggest an easing in price pressures. Lower German rates should in theory relieve pressure on the krone and the franc, both members of the ERM's hard inner core.
But analysts worry that German rate cuts will not be enough to deter the speculation, which could threaten the continued existence of the ERM in its present form.
Like other ERM member states, France and Denmark have slid into recession but are unable to cut their interest rates fast enough to counter deflationary pressure. With inflation rates well below German levels, both economies are burdened by rising real interest rates that are crippling economic activity.
On Friday, Denmark was forced to raise its discount rate by 2 points to 9.25 per cent in effect lifting real rates above 8 per cent. In France, the state statistics agency recently predicted a 1.2 per cent contraction in national output for 1993, in marked contrast to the Government's forecast of 0.8 per cent.
'It is more and more evident that cuts in German rates are not the solution, because they cannot and will not bring their rates down quick enough,' said George Magnus, chief international economist at Warburg Securities.
Foreign exchange dealers estimated that DM5bn ( pounds 2bn) of central bank reserves had been spent in a support buying operation for the krone and the franc over the last few days to little noticeable effect.
The krone ended just above its ERM floor of Dkr3.9016 to the mark, while the the franc fell below its floor to FFr3.4180.