PAUL WALLACE in London
DIANE COYLE in Washington
The French franc is expected to come under further assault in the foreign exchange markets today after the pummelling it took on Friday.
"This is the crunch point," said Peter Spencer, professor of financial economics at Birkbeck College, London, and an expert on European monetary developments. "Once the market has a currency in its sights, an assault is likely to continue," he added.
The attack on the currency looks like developing into a major test of President Chirac's commitment to the "franc fort'' policy, developed under Francois Mitterrand, of linking the franc to the German mark with the ultimate ambition of entering monetary union in 1999. The Banque de France is likely to be forced to raise interest rates to defend the franc.
However, with the economy weakening and unemployment rising in August, such a step would run counter to President Chirac's objective of creating 700,000 new jobs by the end of next year.
"An aggressive and prolonged defence of the franc using interest rates is unlikely," Julian Jessop, European economist at HSBC Markets, said.
French political leaders yesterday attacked the actions by currency speculators, and reaffirmed their intention to cut the budget deficit to meet the Maastricht criteria for economic convergence and European economic and monetary union.
"I do not want to cut the deficits to please the markets or those I shall call the London gnomes," Alain Juppe, the French Prime Minister, told an RPR party meeting in Avignon. "We must be at the rendezvous of the strong ... those countries which refuse to let things slide ... and at the great rendezvous which Europe has set for the end of the century."
Speaking in Washington, where he was attending the meeting of finance ministers and central bank governors of the G7, Jean Arthuis, the Finance Minister, blamed speculators "who take their money and run" for Friday's assault on the franc, when it lost five centimes against the German mark.
However, Kenneth Clarke, Chancellor of the Exchequer, who is also at the G7 meeting, said: "Markets make their judgements on the fundamentals of economic performance." Referring to the blame heaped on the "gnomes of London'', he said, jokingly, "it used to be the gnomes of Zurich. London is the main foreign exchange centre in the world ... but they are international market makers."
Economists believe that the scope for France to successfuly defend the franc against a further, and sustained, assault by currency speculators is limited.
Mr Jessop said: "An aggressive and prolonged defence of the franc using interest rates is unlikely. The central bank has only been able to sell the 'franc fort' to the politicians on the basis that it means lower interest rates. If interest rates actually have to be raised to defend the currency, the game is up
"There is no doubt that the French franc is too high and real interest rates are too high. The French economy could grow much more strongly without rekindling inflation if it was released from the straitjacket of the 'franc fort' policy."
Slow growth in the economy is making it difficult for France to bring down the budget deficit from its current level of 5 per cent to the 3 per cent level in 1997 that is one of the conditions of the Maastricht Treaty for eligibility to monetary union.
This week's strike of civil servants against the government's proposed pay freeze shows the difficulties Mr Juppe is facing in convincing the markets that the French are willing to swallow the fiscal medicine necessary to achieve EMU.