French rates cut helps franc: Bundesbank rejects fundamental change in European Monetary System

FRENCH banks cut their base rates by a quarter-point yesterday to 9.75 per cent, relieving some of the pressure demanded by efforts to shore up the franc in the European exchange rate mechanism. The franc was steady, closing at around Fr3.38 to the mark, well above its ERM floor.

Edouard Balladur, the new French Prime Minister, said in parliament that he would do his best to ensure that the fall in rates continued. These signs of the French Government's success - for now - in avoiding a run on the franc came as the Bundesbank seemed to have fought off reforms of the European Monetary System.

Despite John Major's hope of remedying the 'fault lines' in the EMS, a report from the EC's monetary committee is likely to recommend no fundamental changes.

The committee, composed of deputy central bank governors and treasury officials, finished work on the report at a marathon meeting yesterday. Despite pressure from some delegations for a more critical stance after last year's currency turmoil, it seemed that the report would simply underline that the EMS and its exchange rate mechanism were basically sound.

Existing rules, particularly on intervention by central banks, should be more closely observed. It will not recommend tighter rules on intervention to support currencies before they hit their floor in the system, according to Alan Donnelly, a Labour member of the European Parliament and a member of its monetary sub-committee.

'The Bundesbank representatives opposed any idea of altering the rules,' he said. This represented a missed opportunity to deter speculators. 'It was an opportunity to minimise the chances of organised speculation, and they have failed.'

The committee also decided not to propose any return of capital controls. The view of the EMS that is likely to result reflects the Bundesbank's opinion of the way that the system should operate. The report of the monetary committee and a parallel report by central bank governors are likely to emphasise that the EMS is not a fixed system of exchange rates, and that realignments have an important role to play. Both are also likely to recommend that a closer watch is kept on instability in the EMS.

The committee's unwillingness to recommend more radical change reflects both a fear of upsetting financial markets and underlying disagreement over the causes of last year's explosion in the EMS.

Some countries blame the Bundesbank for encouraging the view that some currencies - such as the pound, punt, lira and peseta - were ripe for devaluation. They also believe that the Bundesbank did too little to assist these currencies while supporting the franc. But without its consent no changes to the EMS can be made.

The Government has made the correction of the 'fault lines' in the ERM a pre-condition of re-entry to the mechanism, although these have never been specifically detailed.

The monetary committee's investigation, launched at last year's Birmingham summit, was a British initiative. But Mr Donnelly said that Britain had advanced no new ideas for reform, and claimed the Government had used the search for 'fault lines' as a smokescreen to prevent any wider debate about the reasons for Britain's failure to stay in the ERM.