Commentary: Good news and bad for Lamont

At one time, a pound worth dollars 2 might have been a cause for celebration, but the rise against the beleaguered greenback now has a downside. The capital flows out of the dollar and into the mark are making it hard for the pound to keep up with the German currency. Given a floor for sterling in the exchange rate mechanism of DM2.7780, yesterday's close of DM2.8010 is too close for comfort.

The Chancellor's first objective must be to sail through to the other side of the 20 September French referendum on Maastricht without an interest rate rise; it would be unnecessarily damaging to confidence to raise rates, even if he were able to unwind the increase if the French vote 'yes'. But there is good news and bad news on his chances of doing so.

The good news is that the markets still believe him when he says the pound will not be devalued: the forward contracts for sterling show that it continues to trade within its ERM bands, unlike the Italian lira. The bad news is that the central banks' intervention to hold the dollar appears to have been a flop, perhaps in part because the markets believe the US authorities are using intervention as a substitute for more serious changes in policy.

The Chancellor may be luckier. He still has unlimited and open-ended swap arrangements within the ERM, and a comforting pile of foreign exchange reserves which can be deployed next month without fear of discovery before the French vote, thanks to delays in publishing the figures. The markets also realise how deep is his own personal commitment to ERM membership, a commitment that includes a willingness to raise interest rates if necessary.