Sterling still caught in the crossfire

A day of turmoil on the currency markets saw the dollar touch a two and a half year low against the German mark yesterday. It also fell to within one yen of its post-war low against the Japanese currency, before recovering against both the mark and yen.

Sterling was caught in the crossfire. The pound traded below DM2.35 yesterday, and analysts said it could swiftly head for the all-time low of DM2.3147.

The Bank of Japan intervened to keep the greenback above Y97, while the central banks of Italy and Portugal sold marks to help their own currencies. Widespread market rumours of concerted intervention by the world's central banks, particularly the US Federal Reserve, were, however, unconfirmed.

News that IG Metall, Germany's engineering union, would hold a strike ballot early next week strengthened the mark. Investors see the risk of a high pay settlement following a strike as tending to keep German interest rates higher.

Favourable US trade figures for December later helped restore some calm to the foreign exchanges. Although the trade deficit widened to $108.1bn, the biggest since 1988, the gap narrowed sharply between November and December. A trade shortfall of $7.3bn was well below market expectations.

The dollar moved back above DM1.48 from its low of DM1.4760 for the day. Even so, most analysts believed it would continue to fall next week. One reason is the continuing concern that financial collapse in Mexico cannot be avoided. This would pose such a threat to the US financial system that the American authorities would have to commit far more money to a rescue.

A second cause of dollar weakness is the mounting evidence that the US economy is slowing. Keith Edmonds, an analyst at IBJ International in London, said: ``There could be a lower and earlier peak in US interest rates than anybody thought.''

Many were also gloomy about the pound. One London dealer said foreign investors had scanned the past week's headlines and concluded that Britain would have a socialist government by the summer. But Chris Turner, currency strategist at BZW, thought there was a chance sterling would stabilise if next week brought better economic data.

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