Pound set to reach DM3

The pound built on its post-Budget gains yesterday to break decisively through the DM2.95 central rate at which it crashed out of the European exchange rate mechanism in 1992.

As the currency also came close to 10 francs to the pound, dealers said it was now on course to breach the DM3 barrier, causing more pain for exporters and foreign earners, like LucasVarity, GKN and Cadbury Schweppes, all of which saw further falls in their share prices yesterday.

The pound ended up around two pfennigs at DM2.965, its highest level against the German currency for nearly six years, and was close to 3 centimes better against the franc at Fr9.9571, a level not seen since early 1991, having touched 9.9896 at one stage yesterday. The sterling index, which measures the pound against a basket of other currencies, added a further half point to 104, also its peak level 1990.

Many economists said Wednesday's Budget, the first by the new Chancellor of the Exchequer, Gordon Brown, would do little to cool an incipient consumer boom. As a result, the currency markets were now betting on next week's meeting of the Bank of England's new monetary policy committee raising interest rates by up to half a percentage point to attempt to choke off demand, particularly the effect of building society windfalls, making sterling more attractive to foreign investors.

Simon Briscoe, economist at the Japanese bank Nikko Europe, said the Chancellor seemed to be distancing himself from the economy in the short term. "If he really was concerned, he would have raised taxes in the Budget ... I think it will only get worse next week. Our feeling is [the Bank] will raise rates next week and there is more to come."

He expects a 0.25 per cent increase to be announced. A half point jump would send "a very strong message" about the Budget measures, he said.

However, although the pound is likely to go through DM3, Mr Briscoe said there was a growing realisation that it was overvalued.

This view was shared by Marian Bell, economist at the Royal Bank of Scotland, who said the market was pricing in "too early and too steep rate rises." She dismissed suggestions the Bank would increase rates by a half-point next week. "The pound is quite obviously overshooting ... but if I am right about the Bank next week, that could be the trigger for a correction," she said.