Currency chaos hits pound

Full-scale panic returned to the foreign exchange markets yesterday. The weaker European currencies - including sterling, the Italian lira, French franc and peseta - went into free fall for part of the afternoon.

In conditions dealers described as chaotic and frantic, the pound reached a new low of DM2.1890. The lira fell from an opening value of 1,216.5 to the mark to 1,275 in mid-afternoon. The peseta held just above its previous record low of 93.55 to the mark.

Trading volumes were low, but analysts said the currency movements reflected reactions to the Bundesbank's failure to cut German interest rates on Thursday. Rumours and political concerns also played a part in yesterday's panic.

Alison Cottrell, international economist at Paine Webber, said: ``There is talk of capital controls in Spain and Italy, rumours of interest rate hikes, speculation that various countries will leave the exchange rate mechanism. Nobody wants to be parked in lire or pesetas over the weekend.''

The lira was hit by the realisation of how narrowly the Italian budget had scraped through parliament. The country's need for far more radical fiscal reform is expected to trigger an election later this year, even though the government survived this week's confidence vote.

Neil MacKinnon, chief economist at Citibank, said: ``The pound is on the ropes again because investors are unsettled about the political landscape. They have seen the Barings collapse, the electricity shares fiasco and Kenneth Clarke putting his foot in it all week. They are staying clear.''

The latest Gallup poll on consumer confidence, showing another deterioration in expectations about both the economy and personal finances this month, also affected the pound.

Mr MacKinnon said sterling could fall as low as DM2 this year. Other analysts agreed that there was no end in sight to the three-week-old currency market turbulence now that hopes of a cut in German interest rates have been dashed.

Hans Tietmeyer, Bundesbank president, repeated his hints that a small fall in German rates was possible. ``The mark is slightly overvalued against some currencies,'' he said.

It was clear that holding out this hope to the markets would not work a second time. Kit Juckes, at SG Warburg, said: ``It looks as though it would take a huge crisis to make the Bundesbank veer from its course.''

There were, at the same time, few expectations of interest rate increases in the weak currency countries to help stabilise exchange rates. Statistics on the UK and US economies suggest the pace of expansion is slowing.

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