Lamont home to stave off crisis over the pound

NORMAN LAMONT, the Chancellor, will return to his Treasury office tomorrow as pressure to raise interest rates becomes almost irresistible, following the pound's fall to new lows on international exchanges last Friday.

With the Government facing its biggest economic test since the election, Mr Lamont is expected to be in immediate contact with John Major, who also returns tonight. An interest rate rise would increase mortgage costs, dash hopes for recovery and possibly deepen the recession.

Sterling fell last Friday to its lowest level against the mark since Britain joined the Exchange Rate Mechanism two years ago, dropping more than one pfennig to close at 2.8028. This leaves it barely two pfennigs above its lowest permitted level against the German currency. City analysts believe bank base rates may rise by half a point to 10.5 per cent.

The nightmare for the Government is that an interest rate rise might earn sterling only a temporary respite. Fears of a deepening recession could further undermine the currency markets' faith in sterling, leading to another slump in its value and the chance of a further rise in interest rates. Ministers would then face the danger of a vicious spiral, and growing backbench pressure to devalue the pound, or even to leave the ERM, would intensify.

Senior ministers yesterday repeated that sterling levels would be maintained within ERM. But they were also hoping that large- scale central bank intervention to buy pounds would enable the Chancellor to get through this week without an interest-rate rise.

Sterling's problems are partly the result of the dollar's weakness and the mark's strength. German interest rates are seven percentage points above those of the US, making the mark more attractive to investors and raising its value against European currencies.

Efforts by 18 central banks, including the Bank of England, last Friday to buy dollars and pounds - and thus maintain their value - proved ineffective. The markets are likely to test the banks' strength again this week by pushing the currencies even lower. The ERM mechanism requires the authorities of the 12 member states to intervene to stabilise currency movements, and further central bank help for the pound is certain. But the banks will not prop up one currency indefinitely.

Lord Tebbit, a long-standing critic of ERM membership, suggested yesterday that Mr Lamont will face bigger trouble after the French referendum on the Maastricht treaty on 20 September. The former Conservative Party chairman said that the Bundesbank would then be freed from German government pressure to hold down interest rates.