Franc test for ERM

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The Independent Online
THE key link between the French franc and the mark is expected to come under strain this week as speculators sell the French currency following today's first round of national assembly elections.

The Bundesbank's decision to cut its key discount interest rate last week allowed Ireland, Belgium, the Netherlands and Denmark to follow suit. But France could not join the party. Instead, the franc fell towards its floor in the European exchange rate mechanism, forcing the French and German central banks to support it.

The leaders of the centre- right RPR and UDF parties - who are expected to win the elections - have promised not to devalue the franc within the ERM. But the markets are aware that the last time they shared power in the 1980s, they broke exactly that promise.

The franc ended the week at Fr3.4120 to the mark, less than two centimes from its floor in the system, when the authorities are expected to defend it.

Gerard Lyons, chief economist at DKB International, said: 'The biggest risk to the franc is if the first-round elections contradict recent opinion polls and suggest the new government has only a small majority.' This could leave the devaluationists in the new coalition in a strong position, encouraging the markets to test the government's commitment to the franc fort.

The domestic case for devaluation in France is much the same as it was in Britain ahead of Black Wednesday. Interest rates must be kept high to defend the currency, when lower rates are desirable to boost the economy. Key interest rates in France are about 11 per cent - despite stagnant production, falling orders and unemployment of more than 10 per cent.

The authorities still have weaponsin store before devaluation becomes inevitable. Central bank intervention has so far been limited, while the Bundesbank could cut its 'repo' interest rate again.