The stock market showed its biggest one-day gain since the Conservative election victory, with almost pounds 13bn added to the value of shares. The FT- SE 100 index rose 68.9 points to 2,381.9, although trading was thin.
The Treasury's move was seen as reducing the risk of a realignment in the European exchange rate mechanism (ERM) and thus triggered widespread selling of the German mark. The pound rose by four-fifths of a pfennig to DM2.7942, nearly two pfennigs above its ERM floor. At one point the pound rose above DM2.80, a level it regained in after-hours trading.
The dollar gained 2.1 pfennigs to close at DM1.4115 while the pound shed more than two cents to end the day at dollars 1.9815. The mark was depressed by opinion polls suggesting the momentum behind French opposition to the Maastricht treaty might be waning.
The prices of gilts ended the day nearly pounds 3 higher. Trading became so hectic that a temporary halt was called.
Fears of an interest-rate rise receded. The three-month interbank interest rate fell by an eighth of a percentage point to 105 16 per cent and the Bundesbank at its fortnightly council meeting avoided adding to the pressure by leaving rates unchanged.
The Treasury said it planned to borrow 10bn ecu (pounds 7.25bn) in foreign currency, which will be used to buy sterling in the foreign exchange markets between now and the end of March.
This is on top of any other purchases of sterling carried out by the Bank of England to prop up the currency.
Some DM5bn (pounds 1.8bn) will be borrowed in the next few days from international banks, led and guaranteed by the four main London clearing banks. A further DM5bn will be borrowed later in the month. Both sums have to be paid back within three years.
Starting next month, the Treasury will raise a further 5bn ecu (pounds 3.625bn) from the sale of bills. These will be sold 'in a range of markets and maturities', and will be used to raise marks, dollars, yen, Swiss francs and ecus. Further bill sales can then be used to pay off the 10bn ecu borrowed, on which higher rates of interest have to be paid.
'These arrangements demonstrate once again the Government's clear determination and ability to maintain sterling's position in the ERM at the existing central rate regardless of the outcome of the French referendum on the Maastricht treaty,' Mr Lamont said.
The scheme provides a clear financial incentive for the Government to avoid a devaluation of the pound against the mark, which economists fear might form part of a realignment of the ERM if the French vote on 20 September to reject Maastricht.
A devaluation of the pound against the mark immediately after the French referendum would make repayment of the first DM5bn borrowed more expensive. A 10 per cent devaluation would increase the sterling cost of repayment by about pounds 180m.
The pound will also be boosted as the foreign currency that the Treasury raises is sold for sterling in the foreign exchange markets. The sterling raised will then be used to help to fund the shortfall between what the Government spends and raises in tax revenue.
The City believes the sale of gilt-edged government securities has already raised more than pounds 15bn of the pounds 33bn that is likely to be required to fund the public sector borrowing requirement in 1992/3. The funds raised from the new scheme could cut the amount the Government needs to raise from gilt sales during the rest of the year by almost half. The Government might also decide it can afford to raise less from National Savings.
That could allow further cuts in the rates offered on National Savings, which would help to relieve pressure on building society mortgage rates.
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