ERM rate increases calm market fears mayhem in markets

BY DIANE COYLE

Economics Correspondent

The mayhem in the foreign exchange markets subsided yesterday afternoon after the announcement of interest rate increases in France, Denmark and Belgium and helpful remarks about interest rates by US and German policy- makers.

There was no immediate sign that Kenneth Clarke, Chancellor of the Exchequer, and Eddie George, Governor of the Bank of England, had decided at their monthly meeting to put UK base rates up after the recent sharp dive in the pound.

Figures showing a fall in industrial output in January suggested the recovery is slowing, strengthening the case against a base rate rise on domestic grounds.

The markets started the day in a state of panic, thanks to overnight selling of weak currencies by hedge funds on a bigger scale than before. But a series of events restored a measure of calm, starting with the rise in interest rates in three exchange rate mechanism member countries whose currencies have been under pressure. Denmark and Belgium raised rates by one percentage point, while the Bank of France replaced its 6.4 per cent lending rate with an emergency 8 per cent rate.

Subsequent comments by Hans-Jrgen Krupp, a Bundesbank council member, that a cut in German interest rates would be "reasonable," helped. The Bundesbank's president, Hans Tietmeyer, said later they would look to see if there was room for a small rate cut.

Afternoon trading in Europe was soothed even more by the latest testimony of Alan Greenspan, the US Federal Reserve chairman, before Congress. He said: "The weakness of the dollar against other major currencies is both unwelcome and troublesome."

He added that the jury was still out on whether there had been enough US interest rate rises to contain inflationary pressure - a welcome contrast to earlier hints that increases in US rates had come to an end.

Raphael Marrone, an analyst at Deutsche Bank Securities in New York, said: "The feeling here is that this is the time for a pause after a very sharp fall in the dollar."

However, many analysts thought turbulence would return to the markets. Malcolm Barr, at Chemical Bank, said: "There is still a lot of momentum for a stronger mark." Glenn Davies, chief economist at Credit Lyonnais, said: "There has been a pause for dealers to regroup, but there is still a serious risk that we are on the verge of a major financial crisis."

There was no change in British interest rates after the Chancellor and Governor met. The Treasury's report prepared for the meeting said signals on inflation were mixed. Most City economists thought the authorities would wait for another month or two before increasing base rates again, unless sterling fell significantly further. David Hillier, a UK economist, said: "Underlying figures show that manufacturing production has slowed steadily over the past three months. This makes a rise in base rates before the next round of tax increases unlikely unless sterling weakness escalates."

Figures for industrial output in January added weight to this conclusion. Total output fell 0.5 per cent in the month, and manufacturing output fell 0.6 per cent, although recent survey evidence points to a rebound in February.

In the three months to January the total declined 0.6 per cent and manufacturing output fell 0.1 per cent - the first three-monthly decline since August 1993. Warmer than usual weather cut energy output, accounting for two- thirds of the 0.6 per cent fall in production.

Within manufacturing, however, the drop in output spread across a wide range. The biggest fall in the latest three months was in the food, drink and tobacco industries, down 1.1 per cent. Engineering output, the biggest contributor to the total, dropped 0.1 per cent in three months.

The pound closed up three pfennigs at DM2.25 yesterday. The dollar closed four pfennigs up at DM1.39. The French franc edged down another two pfennigs to DM3.55.