THE pound has fallen back below the crucial 10 per cent level in the ERM grid. The Irish currency closed flat against sterling, at 96.08p from 96p a day earlier and at 2.6421 deutschmarks from DM2.6419 and also fell to only 9.89 per cent above the weakest currency in the grid, the French franc.

In previous weeks, the pound has risen to almost 12 per cent above the weakest currency. Yesterday's fall below 12 per cent will give the Government some comfort in its efforts to cap the pound's strength in the system.

Sterling shrugged off the Conservative Party's election manifesto. The policy document pledged to cut spending to below 40 per cent of GDP in five years, retain its 2.5 per cent or lower inflation target and aims to cut the basic rate of income tax to 20 per cent.

Yesterday's fall below 10 per cent is due to the strengthening Italian lira. The lira gained ground yesterday and moved ahead of the French franc after a resurgence of interest in the Italian bond market, Mr Oliver Mangan, economist at AIB said.

The Central Bank is likely to be pleased with the move. In recent weeks, it has been targeting the deutschmark exchange rate, rather than sterling, as inflation fears have receded.

The bank has become more focused on the pound's position in the band after the first two months inflation figures came in well below expectations, Mr Mangan said.

While this has also meant a fall of around 2 per cent to 69.1 yesterday in the trade weighted exchange rate, it appears that retail competition from Britain is keeping inflation in check rather than the exchange rate.

Mr Dermot O'Brien, chief economist at NCB Stockbrokers, said the new focus could also mean interest rate cuts later in the year.

According to Mr O'Brien, US rate increases are likely to prove positive for the dollar and hence sterling. That would exert upward pressure on the pound within the EBM.

Under these circumstances the bank is likely to cut rates in a bid to keep the pound under the 15 per cent limit, he said.