Pressure on franc to test French resolve

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THE FRANC is expected to come under renewed pressure this week as the foreign exchanges test the French government's resolve to hold its link with the mark, write our economics staff.

The centre-right government in Paris has already lost its gamble to cut French interest rates below those in Germany. Thanks to the plunge in the franc on Friday to within three centimes of its permitted floor in the exchange rate mechanism, France's interest rates are once again above Germany's.

Despite intervention by the Banque de France, the franc sank below the psychologically important FFr3.40 to the mark, before recovering to close at FFr3.4007, a 15-week low.

Paris money market rates were allowed to rise sharply to attract foreign funds and bolster the franc. Three-month interest rates closed at 7.5 per cent against 7.25 per cent in Frankfurt, bringing to an end the brief month-long interlude in which French rates dipped below German ones.

For shorter maturities, the rise in Paris interest rates was even sharper, with one-month money rates rising to 8.5 per cent and overnight money as high as 9 per cent.

The pressure on the franc has mounted with market fears that the government might break free from the ERM to get interest rates down to kick-start a recovery. The report on Thursday from Insee, the leading French forecasting institute, predicted the economy would shrink by 1.2 per cent this year.

The Prime Minister, Edouard Balladur, tried to placate the markets by saying he was 'totally determined' to stick with the parity against the mark. Previously, he said rumours of any rupture with the mark were farcical.

In Britain, a week of important economic indicators will provide new evidence of whether the recovery is being sustained. Official figures are forecast to show a 0.2 per cent rise in factory output in May, down from 0.7 per cent in the previous month.

In a circular published today, Roger Bootle, chief economist at Midland Global Markets, says base rates ought to be cut again because of the weakness of the recovery and the strength of the pound. 'The economy is going nowhere fast. The economy will struggle to grow by 1.5 per cent this year and 2 per cent next, unless base rates are cut,' he said.