ERM totters in stampede from French franc: Currencies across Europe shaken despite mass intervention as speculators hedge against devaluation by Paris

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The Independent Online
THE BUNDESBANK and the Bank of France bought billions of French francs on the foreign exchanges yesterday, as massive selling of the currency pushed the European exchange rate mechanism near to collapse.

The central banks were thought to have spent DM15bn (pounds 6bn) of foreign currency reserves in the rescue operation, although some dealers said the figure was nearer DM50bn (pounds 19bn). 'This is a genuine crisis, not just a flash in the pan,' George Magnus, of the City firm Warburg Securities, said.

Despite the massive intervention, the central banks failed to dislodge the franc from the bottom of the ERM. It closed unchanged on the day at Fr3.4180 against the mark, 1.25 centimes from its floor in the system.

The Spanish peseta and the Portuguese escudo were also dragged towards their floors in the ERM, having begun the week as the two strongest currencies in the system. The peseta fell below its central rate in the system for the first time since it was last devalued. It traded at 80.23 to the mark, compared with its floor of 84.03.

The Danish krone was weak, despite a 2 percentage-point rise in the Danish 'repo' interest rates to 11 per cent. The Scandinavian currencies outside the ERM also suffered, forcing the Swedish and Finnish banks to intervene in their support. Even the Belgian franc - one of the ERM's 'hard-core' currencies - came under pressure.

Dealers reported that American investors, as well as Europeans, were increasingly switching funds from the franc and other weak ERM currencies to the mark. French companies were reported to be hedging against a franc devaluation. But there is no sign yet that the main speculators, such as George Soros's Quantum Fund, are gambling on an imminent devaluation of the franc.

In an attempt to make speculation more difficult, the Bank of France suspended the facility that allows banks to borrow from it for between five and 10 days. This helped to force short-term French interest rates higher, although the bank is expected to give a clearer signal today that rates should rise. The same tactic was tried when the franc last came under severe pressure in January.

Dealers said the franc might well suffer the same fate as the pound, and be forced out of the ERM altogether. For the French government, the dilemma is that while interest rates need to be cut sharply to pull the economy out of recession, they have to be kept in line with Germany's to keep the franc above its permitted floor in the ERM. The Bundesbank is reluctant to help by cutting its rates again while German inflation is high.

Inflation figures for one of the German states, North Rhine Westphalia, are expected today. Alison Cottrell, of Midland Global Markets, said a high figure would mean 'there is nothing the French or the Germans can do'.

Most economists said the ERM was likely to survive until the weekend, perhaps helped by a hint of flexibility from the Bundesbank. Attention would then rest on Thursday's meeting of the Bundesbank council, the last before its summer recess. A substantial cut in the discount rate - the floor for market interest rates - would then be needed to give the French room for manoeuvre.

The severing of the link between the franc and the mark - either by a franc devaluation or by French departure from the system - would almost certainly spell the end for the ERM in its current form. There was some speculation that the French and Germans might forestall such a move by opting for an immediate move to monetary union, irrevocably fixing the franc/mark exchange rate.

The pound enjoyed 'safe-haven' status outside the ERM, rising 0.77 pfennigs to DM2.5767. But it dropped by 0.7 cents against the dollar, another safe-haven currency, to close at dollars 1.5055. The pound then wobbled in after-hours trading on nervousness ahead of the Commons votes on the Maastricht treaty.