The unusual fall below official German rates looked certain to hold and follows a fall in French market rates below equivalent German rates some weeks ago. France was forced to reverse its first tentative step below German rates in early 1991, when confidence in the mark was much stronger than in the franc.
Yesterday's move was made easier by a climbing dollar, which weakened the mark against other European currencies and left the European exchange rate mechanism relatively free from tension. It also strengthened the view that France and other countries in the core of the ERM could lower their rates further, as the mark temporarily abandoned its ERM anchor role in the markets' eyes.
The French franc softened slightly to 3.3605 to the mark after the reductions were announced, but was still far above its ERM floor.
The dollar's sharp rise since last Friday, triggered by the unexpected collapse of the Japanese yen last week, extended further yesterday, as Japan's political crisis drove the Tokyo stock exchange's Nikkei average down by almost 3 per cent to 19,212.43.
The US currency closed nearly a pfennig higher at DM1.6880 but was below the day's best levels. The dollar was also almost two yen higher at Y110.85 while sterling lost one cent to close at dollars 1.4865.
But there were predictions yesterday that the room for manoeuvre for France and other ERM countries was limited unless the Bundesbank eventually followed suit with rate reductions of its own. 'Because these countries are taking advantage of their appreciating currencies, there is a limit to how far interest rates can fall within a fixed exchange rate system without ultimately pricing in a devaluation of the mark,' said Jane Edwards of Lehman Brothers.
The Banque de France cut the intervention rate a quarter-point to 7 per cent, while the Netherlands, Belgium and Portugal shaved their official rates in sympathy. So did Austria, which is outside the ERM and the European Community but links its currency closely to the mark. Speculation mounted that Spain would soon follow suit.
The French intervention rate compares with a German discount rate of 7.25 per cent and a securities repurchase rate of 7.60 per cent.
Analysts said France would continue to take its cue from Dutch rates, which because of the Netherlands' current account surplus, low inflation and hard currency record, were the most sharply below German rates.
Late yesterday, Dutch three-month euro-rates were 6.6 per cent, against around 7 per cent for France and about 7.35 per cent in Germany. This suggests that the Banque de France could cut rates as much as half a point without disturbing the financial markets.
But in Germany deep concern was voiced over yesterday's developments, despite a slowing in German money supply growth, M3, to an annualised 6.7 per cent in May, against 7.3 per cent in April. Although the easing was at the high end of market expectations, it might have been seen as a trigger for lower German rates but for the weakness of the mark.
Eberhard Martini, president of the German Banking Association, said: 'The observable uncoupling of interest rates in some neighbouring countries from German rates should be taken as a serious warning.' International confidence in the mark would be at stake without a turnaround in German financial policy.
Wilhelm Gaddum, a Bundesbank board member who is soon to become the central bank's vice-president, said great efforts would be needed to preserve the mark's stability. 'Sacrifices will be inevitable,' Mr Gaddum said, referring to the government's discussions about savings worth well over DM20bn in next year's budget.
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