At one stage the pound was worth more than dollars 2, gaining more than six cents on the day. But with the German mark benefiting even more from the dollar's weakness, sterling remained beleaguered within the European exchange rate mechanism (ERM) and fears grew that the Government could soon be forced to raise interest rates to stop the pound falling through its floor.
However, a full-blown sterling crisis was averted; the pound closing just a little weaker against the mark on the day.
But government relief that the predicted sterling crisis still turned out, for the moment, to be a dollar one was overshadowed by bad balance of payments figures.
Number 10 sources played down the 'gloom and doom' predictions of an interest rate rise and played up a 1 per cent rise in the volume of non-oil exports as a 'healthy sign of recovery'. But as Downing Street's warning that the Government would do 'whatever is necessary' to protect the pound proved unnecessary, opposition parties seized on a 1 per cent rise in the volume of imports as proof of a sick economy.
Billions of pounds were wiped off the value of London shares as the stock market contemplated the effect of higher interest rates on companies, consumers and the economy.
The markets were also buffeted by news that Britain's trade unexpectedly slid deeper into the red last month to pounds 1.13bn. And a survey for the European Commission showed consumer confidence plunging to a two-and-a-half year low, threatening another downturn in high street spending.
The Bank of England gave a clear signal yesterday morning that a rise in base rates from 10 per cent was not imminent, but the City remained highly sceptical. The key market interest rate which tracks base rate expectations is pointing to at least a half- point rise, with many economists believing the Bank may be forced to lift rates by a full point or more.
The pound survived a chaotic day on the foreign exchanges relatively unscathed. It closed at DM2.8010, just over 2 pfennigs above its lowest permitted level in the ERM.
Sterling was trading below the psychological barrier of DM2.80 at one point, with dealers reporting that the Bank was quietly intervening to prop it up.
The dollar fared far worse, as investors rushed to take advantage of the higher interest rates offered on the mark. The Federal Reserve (the Fed) and European central banks - including the Bank of England - bought hundreds of millions of dollars in two concerted waves in the morning, with the Fed intervening three times on its own later in the day.
But the intervention proved futile. The pound closed at dollars 1.9955, while the dollar shed 4.3 pfennigs to close at a record low of DM1.4060. Sterling briefly rose above dollars 2, making a dollar worth less than 50p, a level it has not closed at for more than a decade.
Economists believe investors will not stop selling dollars and buying marks until the Bundesbank cuts German interest rates or the Federal Reserve raises rates in the US. Downward pressure on the dollar is expected to put more pressure on the pound, with the Government's apparent concern to do anything possible to avoid higher interest rates adding to market nervousness.
Number 10 was keen to make clear no face-to-face discussion between John Major, the Prime Minister, and Norman Lamont, the Chancellor of the Exchequer, was scheduled for yesterday.
John Carlisle, Tory MP for Luton North, who last month called for Mr Lamont's replacement, told Radio 4's PM the Chancellor had been warned not to appear on television or radio 'because if he does the pound goes down'. His position must now be in great jeopardy, Mr Carlisle said.
Labour repeated calls for discussions with other EC finance ministers on co-ordinated Europe-wide action on interest rates and unemployment, while the Liberal Democrats urged regeneration of the construction industry and a clear commitment to joining the narrow bands of the ERM to secure confidence in the money markets.
Robin Cook, Labour's trade and industry spokesman, said the trade gap was already greater than the whole of last year's.
'We are now adding a million pounds to the trade deficit every hour,' he said.
John Smith, leader of the Labour Party, said in Edinburgh last night: 'I think the trade balance is really quite serious. Here we are in the middle of a very deep recession with a really quite appalling trade balance and I think it's quite clear that if the economy is to be allowed simply to drift with no action taken by the Government then we are going to be in even more serious problems.'
Stick to their guns, page 17
Market reaction, page 18
Commentary, page 19
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