The European Crisis: Paris props up currency

THE FRENCH central bank was reported yesterday to have spent up to half its foreign exchange reserves in a last-ditch support-buying operation to prop up the franc.

The franc came under pressure as the European exchange rate mechanism was subjected to its severest strains since the pound and the Italian lira left the system last week.

The Danish, Spanish and Irish central banks intervened to support their currencies as international investors speculated on an imminent realignment of the remaining currencies in the system, with the German mark's band of permitted variation moving upwards against other ERM currencies. Rumours of a realignment swept the markets throughout the day. But Alison Cottrell, an economist at Midland Montagu, said the central banks would do everything they could to avoid one in order not to hand the speculators another victory.

The Bundesbank and other central banks in the German block helped intervene to support the weaker currencies. It was reported that the Bank of France and the Bundesbank had spent nearly pounds 18bn in recent days trying to defend the franc.

Tensions within the ERM were exacerbated by disappointing German money supply figures for August - 9 per cent higher than the average figure for the last three months of 1991. The Bundesbank target range was 3.5 to 5.5 per cent.

Economists said the acceleration in money supply growth made it more unlikely that the Germans would agree to the interest rate cut which is widely seen as necessary to accompany any realignment in bringing stability back to the ERM.

Gerard Lyons, an economist at DKB International, said: 'The ERM is in need of a dramatic overhaul, including a realignment and a return to the more flexible operating system which ruled before 1988.' He added that the key test would be whether the French were prepared to have their currency decoupled from the German; if not French interest rates would have to rise.

It was also announced that the Italian money markets, due to reopen yesterday, would remain closed until further notice because of 'conditions of uncertainty'.

The treasury ministry statement stressed that the government intended to reassume its obligations under the European Monetary System very soon.

Initially the Italian government had intended to return the lira to the ERM yesterday.

The lira remained fairly stable against the German mark and gained against the dollar and the pound on international markets.

The pound was sidelined by the turmoil in the ERM, but ended the day nearly a pfennig above Monday's close at DM2.5457. The pound had been rising as Norman Lamont, the Chancellor of the Exchequer, announced the one-point cut in British interest rates because of a large commercial order for sterling.

It then drifted down during the day, reaching a new all-time trading low of DM2.5160. The pound closed on a higher note, dragged up by a rising dollar.