Interest rates fear as pound and dollar fall

Sterling slumped yesterday to its lowest point since joining the European Monetary System (EMS) nearly two years ago, deepening fears of a damaging rise in interest rates.

The pound dropped more than a pfennig from Thursday's close to trade at DM2.7950 in New York yesterday afternoon, barely

1.5 pfennigs above its absolute EMS floor. In the City, apprehension grew that base rates might rise half a point, to 10.5 per cent. That could damage economic confidence and deepen recession by curbing consumer spending and industrial investment.

In London, the dollar finished 0.10 pfennigs up from Thursday's close at DM1.4492. In New York, it hit an all-time low of DM1.4245. Its fall killed hopes for a stock market rally in the wake of George Bush's nomination as Republican presidential candidate, forcing the New York Stock Exchange to curb program trading when the Dow Jones Industrial Average fell more than 50 points to close at 3254.10.

The US Federal Reserve yesterday led the world's main central banks in a futile attempt to halt the dollar's fall and prevent the currency from becoming an issue in the US presidential election.

In five waves of substantial intervention yesterday afternoon, at least 18 leading central banks failed to lift the dollar noticeably higher, despite flooding the market with an estimated DM3bn.

Concern grew in the markets that a 'dollar crisis' might be brewing that would expose the impotence of central bank intervention without substantial changes in US economic policies.

The Bank of England, which joined the intervention, was also thought to be buying pounds for marks to prop up sterling. Here, too, the support proved ineffective. In London, sterling ended half a pfennig down at DM2.8028.

The three-month interbank rate, which offers a reliable guide to City interest rate expectations, rose to 10-3/8 per cent compared with 10-1/4 per cent on Thursday. Nevertheless, economists felt the Bank of England would steady sterling with intervention rather than higher interest rates before the French referendum on the Maastricht treaty on 20 September. They pointed out that below DM2.80 speculating against the pound becomes expensive, unless traders believe a devaluation inside the ERM is in prospect. Some economists also argued that sterling's weakness reflected the belief that higher rates could actually weaken sterling because of the damaging impact on the economy.

Officials of the Group of Seven leading industrial countries said yesterday that the co-ordinated intervention was led by the Fed. They indicated that the US Treasury was growing increasingly worried that a further sharp dollar decline against the mark might hand a potent new issue to Bill Clinton, the Democratic presidential contender.

UK national output dropped by 2.4 per cent in 1991, the steepest fall recorded by the Central Statistical Office since records began in 1948.

The figures were issued ahead of the September release of the CSO's Blue Book of national accounts of the UK economy, which has been updated to include data for 1991.