The pound has risen above 85p sterling as the British currency was hit by a flow of funds into the deutschmark. Sterling fell by almost four pfennigs as rumours of a German interest rate rise began circulating. The pound closed at 85.60p against sterling in late trade from 84.97p on Friday.

According to Mr Jim Power, chief economist at Bank of Ireland, there has been a "fundamental reassessment" of where German interest rates go from here. The markets believe that, following the weekend EU meeting in Brussels, the Bundesbank will tighten rates probably before July. This is likely to put back Irish rate cuts and will mean they may be smaller than had been expected.

Bundesbank council members are seen as less than pleased about the political horse-trading over the top job at the European Central Bank.

Council member Mr Klaus-Dieter Kuhbacher, president of Berlin and Brandenburg state bank, accused the heads of state of having "screwed up". Analysts now believe that the Bundesbank will seek to establish the credibility of the new regime by hiking rates.

Dr Dan McLaughlin, chief economist at ABN Amro, said the Bundesbank would now be pulled in two directions between the needs of the German economy and those of the region as a whole. The peripheral countries with interest rates currently over 5 per cent account for 35 per cent of gross domestic product, he noted. As a result, euro interest rates are likely to increase by more than expected.

On top of that, there is now a feeling that British rates have peaked and may even go into decline over the coming months as the economy turns down.

Mr Power added that the weekend setting of euro exchange rates and participating countries has removed uncertainty and thus much of the logic of sterling as a "safe haven" currency has been removed. Dr McLaughlin said he now expected the pound to rise to around 86p by the end of June and to 90p as sterling declined by the end of the year.

"Yesterday's Danish rate rise is emblematic of a view that is out there that German rates are going up," Mr Jim O'Leary, chief economist at Davy Stockbrokers said. "At the same time, UK rates have peaked and the only surprise likely is that they will be cut sooner than expected."

Mr Ken Wattret, economist at Paribas in London said he expected the stronger deutschmark trend to continue because speculation about a German rate rise was here to stay. He added that talk about a hike in the near future was misplaced.

Earlier in the day, there had been speculation that Mr Tietmeyer was ready to quit and that rates would be increased as a result. The talk of a resignation by the president was firmly denied by the Bundesbank.

An anticipated quarter percentage point cut in Spain's key rate to 4.25 per cent on Tuesday did little to quash such speculation. Instead, traders focussed on a surprise half percentage point rise in Danish rates, which helped boost the D-mark against the dollar, sterling and the yen.