THE Central Bank's moves to support the pound have pushed money market rates up to levels which indicate an increase in hank and building society rates. However, the hank is unlikely to allow a rise in rates given the difficulty it is having in the currency markets.
Over the past week to 10 days, the bank is estimated to have spent at least £300 million buying the pound to stop it falling against sterling. But despite continued intervention yesterday morning, the pound slipped against both sterling and the deutschmark in late trading, slipping to 94.25p against sterling from 94.99p a day earlier and to DM2.6485 from DM2.6649, despite closing official trade marginally up against the German currency. It remained at the top of the ERM grid 11.37 per cent above the weakest currency, the French franc.
Mr Jim O'Leary, chief economist at Davy Stockbrokers, warned that many investors now believe the pound is a one way bet and has to fall. As a result there has been heavy selling over the past two weeks, with the bank forced to intervene to stop the currency slipping too far, too fast.
Substantial selling from the US over the past couple of nights has added to the pressure.
However, the collateral damage according to Mr O'Leary is that there has been upward pressure on inter bank rates which have now risen above 6 per cent, seen as the key level indicating pressure for a rise in retail rates.
If the key one month rate remains at 6 per cent or above for a week or two, the lending institutions will be likely to consider raising rates for personal loans and mortgages.
Normally, the bank would move into the market itself to try and mitigate the rate rises but so far it has failed to do so. Nevertheless, the bank will not be keen to allow a rate rise which would exacerbate its problems in the ERM band, possibly pushing the pound closer its 15 per cent limit in the band.
According to Mr O'Leary, the authorities are in a bind the markets are so convinced that the currency will have to be allowed to fall that it will be difficult for the bank to keep up its intervention.
The reason for this growing conviction is a belief that the central parities in the ERM will be used to convert the various currencies into the euro. If this system is to be used, the pound will have to fall to DM2.41 by the end of next year.
However, the Minister for Finance, Mr Quinn has said there is no indication yet of how the decision will be made on the rates at which the different currencies will enter monetary union.
Most analysts believe that the authorities have been taken aback at the scale of the recent moves on the foreign exchange markets, hoping that the currency would gradually drift back, rather than be hit by waves of sellers.
The Central Bank is likely to want to wait at least until the summer before allowing the currency to fall in order to check that no inflationary pressures are coming through because of the recent fall against sterling.
The problem for the bank in managing the currency is that it is still unclear where sterling is going. If it falls against the D-mark over the rest of this year, as most commentators are predicting, a fall in the pound could be accommodated.
On the other hand, if sterling were to appreciate further to over three deutschmarks, it would be very difficult for the pound to enter the single currency at its current central parity of DM2.41.
"What happens if the view that sterling strength must be transitory is wrong?" he asked. "We cannot strike for the central rate if we do not know what sterling is doing."
