France in new pact to defend franc

FRANCE has indicated its readiness to raise key interest rates after securing a cast-iron guarantee from the Bundesbank to defend the French franc from the latest eruption of pressure in the European exchange rate mechanism.

As rumours swirled yesterday that France and Denmark were preparing to quit the ERM, the Banque de France joined forces with the Bundesbank, intervening heavily to prevent the franc from hitting its ERM floor.

The franc dropped as low as Fr3.4236 to the mark at one stage before intervention drove it back to Fr3.4170 - little changed from the Thursday close - compared with an ERM floor of Fr3.4305.

Dealers in New York estimated that the Banque de France had spent the equivalent of about Fr30bn this week in defending the French currency. Intervention picked up steadily during the week as pressure on the franc mounted.

The devaluation rumours were said to emanate from US sources and may have the tacit support of the US government, which was pressing for a general ERM realignment last summer in meetings of senior officials of the Group of Seven.

To counter the rumours, top French officials let it be known that they were ready to lift official interest rates next week, despite the squeeze that a tight monetary policy is having on the French economy. The current five to ten- day borrowing facility, equivalent to the French discount rate, could be lifted to between 13 per cent and 15 per cent from the current 10.5 per cent.

In addition, French officials have told leading French commercial banks that the Bundesbank is ready to support the franc as heavily as it did last September, when unprecedented tensions broke out in the ERM. But the latest bout of pressure on the ERM also reflected concern that the European Community summit in Edinburgh may fail to achieve a breakthrough on the EC budget and Maastricht, setting the scene for further turmoil in the system.

In Edinburgh, Theo Waigel, the German Finance Minister, said there was no need for a devaluation of the franc and added that the finance ministers were not discussing an ERM realignment. His denial was backed up by other Community finance ministers.

EC finance ministers are in Edinburgh to break the deadlock on future financing of the Community and to prepare a European growth package. But central bank officials, who would be needed for a meeting of the European Monetary Committee, are not attending the Edinburgh Summit.

Without agreement in Edinburgh, the ERM is expected to come under fresh pressure next week with the Irish punt seen as the most vulnerable currency. Despite the approach of Christmas, some analysts expected the markets to be lively next week if the ERM was threatened with renewed upheaval.

The Danish krone and the punt were yesterday both pushed back towards their ERM floors, despite intervention from the Belgian and Danish central banks.

France is meanwhile understood to have abandoned any attempts to narrow its ERM fluctuation bands from the current 2.25 per cent margins either side of the central rate. The French government had been debating whether to join the hard currency core - Belgium, the Netherlands and Austria - which limit currency fluctuations against the mark to 1 per cent or less. The French plan was to strengthen the defences against speculative attack and to accelerate monetary union with Germany. But the plan was likely to be revived if it became clear that Britain and Denmark would fail to ratify the Maastricht treaty.

In the currency markets, there were mixed opinions on whether the franc-mark rate - the linchpin of the ERM - could be defended successfully. John Hall, of Swiss Bank Corp, said: 'The franc will survive.' But Ifty Islam, of Barclays de Zoete Wedd, said: 'Since September, pushing a currency to its ERM floor is no longer seen as a danger zone for traders. The foreign exchange markets are no longer scared of the central banks.'