Intervention helps franc to pull through: Bank of France raises overnight interest rates by 2.25% in attempt to deter speculators on a devaluation

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The Independent Online
THE AILING European exchange rate mechanism yesterday struggled successfully through to the weekend with the franc and other weak currencies in the system remaining under severe speculative pressure.

The Bank of France and the Bundesbank were reported to be buying francs for much of the day, but in much smaller volumes than on Thursday, when estimates of intervention varied from DM15bn ( pounds 6bn) to DM50bn.

The Bank of France pushed its overnight interest rates up from 7.75 to 10 per cent in an attempt to make speculation on a franc devaluation more expensive. Along with the intervention, this succeeded in keeping the French currency around Fr3.4180 to the mark. It ended the ERM's trading day at Fr3.4175, some 1.3 centimes from its floor in the system. The Danish krone fell to end the day as the ERM's weakest currency at Dkr3.8885 to the mark.

Malcolm Barr, economist at Chemical Bank, said Thursday's dramatic intervention by the central banks had drawn a 'line in the sand' at Fr3.4180, which was being maintained more easily yesterday by steady buying of the franc at that level. But he added that the trade was all in one direction, with the big New York funds starting to take an interest.

The Belgian franc - one of the currencies in the ERM's 'hard core' - also remained under pressure despite increases in key Belgian interest rates. It reached a self-imposed 0.3 per cent divergence limit from its central rate against the German currency, closing fractionally lower on the day at BFr20.71 to the mark. The Portuguese escudo and Spanish peseta were sluggish but avoided serious selling as they remained on the sidelines.

The markets were thick with rumours of meetings over the weekend to announce the departure of the franc from the ERM, but these were denied by officials from Bonn.

Edouard Balladur, the French Prime Minister on an official visit to Morocco, flatly denied rumours that the franc would be devalued by between 3 and 5 per cent. The French and German authorities also issued a joint statement reaffirming support for the franc's parities in the system.

Much now depends on the attitude of the Bundesbank. Economists believe it will have to cut its official rates next week if the ERM is to have any chance of survival.

The franc's difficulties stem from the dilemma that France needs lower interest rates to boost its economy but has to keep them in line with Germany's to defend the currency. The Bundesbank is reluctant to cut rates while money supply growth and inflation remain high, but most observers believe it will move to save the ERM.

Hopes of a German rate cut were dented somewhat by Reimut Jochimsen, the Bundesbank member who displayed an unfortunate talent for undermining ERM defences with injudicious comments in the run-up to Black Wednesday. 'Public fiscal policy is placing too great a strain on us as borrowing requirements are too high, so that from this point of view a cut in interest rates is not immediately on the agenda,' he said.

But other observers took heart from a Bundesbank move to put a floor under German money market interest rates by issuing three-day day Treasury bills at 7 per cent, helping to mop up liquidity in the banking system.

Attention will now be focused on Tuesday's German 'repo' details, provided that inflation figures from a number of German states due on Monday do not precipitate an earlier crisis. Alison Cottrell, of Midland Global Markets, said the Bundesbank was likely to cut its official discount rate at next Thursday's council meeting by at least half a percentage point from its current 6.75 per cent.

The pound fell to a low of DM2.5490 in the Far East on Thursday night following the Government's defeat in the Maastricht vote, but rose later to open in London around DM2.5740. With the result of yesterday's confidence vote in little doubt, sterling closed just over a tenth of a pfennig down at DM2.5755.

(Photograph omitted)