Franc in ERM firing line: Irish minister blames Bundesbank for 10% devaluation of the punt - Downing Street denies rift with Treasury over interest rate cuts

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The Independent Online
THE FUTURE of the troubled European exchange rate mechanism is hanging in the balance, with currency speculators expected to turn their fire on the French franc after forcing a weekend devaluation of the Irish punt.

However, the pound's suspension from the ERM last September should ensure that fresh turmoil does not for the time being put upward pressure on interest rates, as it did in the run-up to 'Black Wednesday'.

British rates are expected to drop again around the time of the Budget on 16 March. But No 10 took the unusual step yesterday of denying a report that the Prime Minister intended to overrule the Treasury and cut rates by a third, to 4 per cent, by the summer.

'There is no truth in the story that the Prime Minister has taken control of economic policy away from the Treasury', the statement said.

Senior Cabinet colleagues believe Norman Lamont's future as Chancellor rests on the appearance of economic recovery by the summer. But there is some confidence that the recovery is taking place and that he will go on to present a further Budget in


The latest upheaval in the ERM has led to fresh calls for reform of the system, which has been unravelling steadily since the middle of last year. The Irish Finance Minister, Bertie Ahern, blamed the punt's devaluation on the refusal of other ERM central banks - in particular the German Bundesbank - to provide aid.

Mr Ahern said that instead of supporting the punt the Bundesbank had provided 'bilateral aid for the French franc that worked against us'. His claim of favouritism towards the French echoes complaints in Britain in the wake of Black Wednesday.

Irish opposition parties said that Dublin's capitulation to the markets on Saturday meant the punt had been 'thrown to the wolves'. The 10 per cent devaluation, agreed at a four-hour meeting of EC treasury and central bank officials, was the largest in the system's 13-year history.

The ERM has been under severe strain since last summer as Europe has struggled to cope with continued high interest rates in Germany, the system's anchor.

The ERM restricts the extent to which member currencies can fluctuate against each other and other ERM members with depressed economies have found it increasingly painful to defend their currencies by matching high German rates. The Spanish peseta and the Portuguese escudo have been devalued, while sterling and the Italian lira have been forced out altogether.

Speculators may now turn their attention to the next most vulnerable ERM currencies - the franc and the Danish krone. Pressure on the franc is expected to be particularly intense in the run-up to the French National Assembly elections on 21 and 28 March.

Portugal's Prime Minister, Anibal Cavaco Silva, said: 'If there is a problem with the French franc there will be a big problem with the system, and the franc is now in the front line.'

But the Bundesbank is keen to ensure that the franc remains in place. Its demise would effectively leave the ERM consisting only of a hard core of German-bloc currencies - the mark, the Belgian franc and the Dutch guilder.

Alison Cottrell, of Midland Global Markets, believes that the Bundesbank might co-operate in a support-buying operation for the franc or lower money market interest rates, a tactic that relieved pressure on the currency early last month. 'At the end of the day the Bundesbank will come down on the side of the French. It will not want to see the speculators make money on the franc.'

France might otherwise have to raise its rates to defend the currency, a move that could trigger a round of mortgage increases from the French clearing banks. This would put more pressure on its economy, where more than one person in 10 is unemployed and growth is expected to be slow.

The punt was pushed over the edge last week by the decision to cut base rates in Britain to a 15- year low of 6 per cent, triggering a slide in sterling. Britain is the market for a third of Irish exports, so the lower pound resulted in a severe loss of competitiveness for many Irish companies.

The eventual devaluation of the punt has been seen as inevitable for some weeks - Mr Ahern said that in a single deal one speculator had bet Ir pounds 500m on a fall in the punt. Officials in Dublin are worried that further falls in sterling could put it under pressure again.

Leading article, page 18

Conflicting signals, page 20

Gavyn Davies, page 21