Paris and Bonn fuel storm over new EMS

An explosive row is likely to follow Tuesday's accord between Paris and Bonn on the formation of a new exchange rate mechanism for countries that do not join the single European currency.

Although monetary union is not on the agenda of the Turin summit, which begins today, sharp disagreements are likely to surface. The principal purpose of the summit is to launch the Inter-Governmental Conference, which is to rewrite the Maastricht treaty.

Reactions to a plan on relations between the "ins" and the "outs", agreed by finance ministers Jean Arthuis and Theo Waigel in Laval, northern France, on Tuesday, have been hostile, especially in Britain.

The Government is determined not to take part in a formal mechanism for the currency after the pound's disastrous exit from the Exchange Rate Mechanism in September 1992.

The Franco-German announcement has also fuelled tension between the German government and the Bundesbank. The bank is alarmed by signs that Chancellor Helmut Kohl wants a single currency to start on time, even if the Maastricht criteria for membership are fudged.

A powerful ally of Mr Kohl yesterday called on the Bundesbank to back the government over European monetary union. Wolfgang Schauble, leader of Kohl's Christian Democrats in the Bonn parliament, said: "The German Bundesbank is bound by law to support this policy."

Speculation about a rift between the powerful central bank and the Bonn government has spread since the Bundesbank's president, Hans Tietmeyer, said a single currency was not absolutely necessary. Mr Tietmeyer on Tuesday stressed he did not favour delaying monetary union but Bundesbank officials privately continue to express concern over the timetable.

France and Germany are, nevertheless, determined to press ahead with the 1999 start date for the single currency and to protect their economies against "competitive devaluations" by countries left outside. The lower pound and lira since Britain and Italy left the Exchange Rate Mechanism in 1992 have had a severe impact on exporters. France has complained loudest, but German companies also have been affected. Many switched production to the UK and Italy.

The British authorities, both ministers and the Bank of England, firmly oppose rejoining a new Exchange Rate Mechanism. Officials argue a formal "ins" and "outs" arrangement would create a fault-line in the EU. "It is pretty obvious the 'ins' would hold their own meetings in advance of the formal ones, which would then be expected to rubber-stamp everything," a senior official said.

Officials share the view of the financial markets that creating a new ERM would invite speculative attacks against 'out' currencies. This view is widespread in London's currency markets. "Targeting by the central banks would be an invitation to destabilise the currencies", said a trader at a US investment bank.

The Italian lira looks most vulnerable. Analysts talk of a "nightmare scenario" in which exclusion from the single currency leads to an abrupt halt to Italian efforts to cut the government deficit, a nose-diving exchange rate, and a government default on its debt.

News analysis, pages 14, 15 Leading article, page 18

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