Major seeks ERM reform: Britain blames 'fault lines' for sterling crisis and demands European monetary policy 'run in interests of all countries'

JOHN MAJOR said last night that 'fault lines' in the exchange rate mechanism (ERM) would have to be cured before sterling returned to the fixed-rate system. 'Clearly, it is not imminent,' he added. Interviewed on BSkyB, the Prime Minister said that when the ERM worked, it was the best method of bringing down inflation, an objective that remained at the centre of government economic policy.

He confirmed his commitment to the Maastricht treaty, which, he said: 'Provides for the development of European policies outside the Treaty of Rome, outside the European Court and outside the authority of the European Commission. We have sought that British policy for years.'

But in what appeared to be a reference to German bias in the ERM, he said: 'We have seen fault lines in the ERM revealed over the past few days. We need to examine it, to look at those fault lines and see how they can be cured. We have to make sure that monetary policy is run in the interests of all the countries of Europe and not veered to the national interests of any individual country.'

John Smith, the Labour leader, said: 'Once again, it is the nasty foreigners who are at fault.' The plain truth was that the problems arose from the weakness of an economy that the Conservatives had run for 13 years.

Earlier, Norman Lamont - who was stoutly defended by Mr Major - provoked a spat with Helmut Kohl, the German Chancellor, when he elaborated on the conditions for ERM re-entry. The Chancellor of the Exchequer said: 'We want to be satisfied that German policy, which has produced many of the tensions within the exchange rate mechanism, is actually going to have some changes and be able to operate within a more stable environment.' Mr Kohl said he considered Mr Lamont's remarks 'inappropriate for a minister'.

When Mr Major was asked whether he accepted Mr Kohl's rebuke last night, he redirected the fire from German policy to Bundesbank leaks about realignment. 'I don't think Dr Kohl can have heard precisely what the Chancellor said,' he told ITN. 'If anything was inappropriate, it was the reported comments that did so much damage on the exchange markets in recent weeks.'

The Prime Minister said Mr Lamont had been criticised for courageously pursuing a policy that had brought inflation down from almost 11 per cent to 3.7 per cent. 'The Chancellor's policy is my policy,' he said. 'The Chancellor's policy is the Cabinet's policy.'

Mr Major said that he hoped for a French 'yes' in tomorrow's referendum on Maastricht, but he added that whatever the result the last few months had shown that the people of Europe increasingly supported British initiatives to increase democratic accountability, devolve Brussels power and put greater emphasis on the individual nation states.

That 'British instinct', which had been spurned as isolationist in the past, had gained 'massive support' among the people of Europe. 'That is a very attractive development or European thought,' he said, 'and it will lead to a very attractive development of European policy.'

Earlier, on BBC radio, Mr Lamont said the objective of curbing inflation would remain 'the centrepiece' of government policy. But he excited the hopes of some Conservative MPs that further interest rate reductions were on the way when he added: 'That means that monetary policy must be set at a level that will bring that about and help to create a revival in the economy.'

The Chancellor said that with the pound floating outside the ERM, he would pursue 'a British economic policy and a British monetary policy', and he recalled: 'At the beginning of the '80s, we went through a period very similar to what we're going through now. We got inflation down, and then there followed a prolonged period of sustained growth on the back of low inflation.'

As for sterling's re-entry into the ERM, government sources suggested it was unlikely that the 'fault lines' would be cured before the end of the year. Specifically, Mr Lamont said: 'I want to ask some questions about the way in which co-operation between governments works.'

The belief that Britain will remain outside the ERM for some time fuelled hopes in the City that interest rates could be cut as early as next week. That prompted another surge on the stock market, with the FTSE index rising by 83.1 points to 2,567.

City economists believe base rates could well be down to 8 per cent by the end of the year, from their current 10 per cent. Easing rates could also be made easier if Germany cuts rates next week to help to revive the ERM after the French referendum. The prospect of lower interest rates also saw the pound fall again to a new record low against the mark, dropping 1.73 pfennigs to DM2.6106. The pound also fell by nearly 5 cents against the dollar to dollars 1.7430.

Lamont faces clash, page 2

Gould could resign, page 3

Bonn plots response, page 4

Leading article, page 16

Sandra Barwick, page 17

Money supply figures, page 19