The speculation was preceded by a steep fall in the dollar, reflecting expectations of a half-point cut in the US discount rate, to 2.5 per cent, following a widely feared slump in September employment figures when official figures are released on Friday.
Against the pound, the dollar fell more than 4 cents to end at dollars 1.7700. It fell 2.60 pfennigs to DM1.4285. The pound meanwhile recovered 1.13 pfennigs to DM2.5239.
Fears of poor employment figures fit in with other figures pointing to a fading US recovery. A possible defeat for President Bush in the November presidential elections is also weakening the dollar.
Yesterday, US leading indicators for August fell 0.2 per cent, and the Conference Board said its index of US consumer confidence declined again in September as consumers became dispirited about future economic prospects.
Although the dollar fell across the board, the marked decline against the pound was due largely to Middle East investors who unwound short positions taken out against sterling two weeks ago.
Hopes of lower German rates helped to turn around a 28-point fall in the FT-SE 100 index, which ended up 5.5 at 2,565.5.
Some believe the Bundesbank will go to great lengths to avoid another upheaval in the European exchange rate mechanism which could be unleashed if it decides to leave rates unchanged.
Robin Leigh-Pemberton, Governor of the Bank of England, appeared to bolster hopes of lower German rates when he said that a relaxation of monetary policy by countries 'with strong currencies and a satisfactory price performance, such as Germany' could have a positive international impact.
But the Bundesbank is known to regard inflation figures as far from satisfactory. Official figures yesterday disclosed that higher housing and service costs pushed up the western German cost of living index 0.3 per cent in September, to stand 3.6 per cent above a year earlier, compared with 3.5 per cent in August.
Theo Waigel, the German finance minister, faced with growing criticism of Germany's financial and monetary policies, told industrial nations to search at home for the causes of their economic woes. He rejected allegations that Germany was responsible for Britain's departure from the European monetary system and continuing global recession.
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