IRISH financial markets are facing into a period of uncertainty after a sharp drop in the value of the pound because of heavy selling by international investors. The pound dropped almost 2.5p yesterday to 92.48p sterling, its lowest level in almost five years, and it lost over seven pfennigs against the deutschmark to close below DM2.60.
Investors are selling the pound because they believe it will join the European single currency, but at a much lower rate against the continental currencies than its recent value on the markets would indicate.
The sharp fall of the pound yesterday followed a decision by the Central Bank to step back - at least temporarily - from supporting the currency on the markets.
The falling pound is leading to some pressure for an increase in interest rates. Market analysts believe that an early rise in bank and building society rates is unlikely and they are reasonably confident that an increase may ultimately be avoided. However, much will now depend on the trends in the money markets in the days ahead.
Selling of the pound started early yesterday. London based traders in particular sold about £160 million in the first few hours of yesterday morning. That is a huge amount for the Irish market, although by late yesterday the market had stabilised and the currency - which fell as low as 91.5p sterling at one stage - had regained some of its earlier losses.
Speculators have been selling the pound for several weeks, with the Central Bank buying most of it back. This has allowed the currency to remain stable despite sizeable selling.
However, after the Central Bank indicated to currency traders that it was stepping back from further purchasing of the pound, the currency fell sharply yesterday.
The Minister for Finance, Mr Quinn, insisted that there had been no change in Government policy. However, as reported in The Irish Times some weeks ago, it is believed that the Government has been keen to see some weakening of the pound in the EU exchange rate mechanism (ERM) to smooth the move to the single currency.
The Taoiseach, Mr Bruton, set the latest events in the market in the context of the move to monetary union and argued that it showed the link with sterling had finally been broken. "The Irish economy makes its own decisions now", he said. "We are decoupled from Britain."
The Government will not welcome the upward pressure on interest rates. The selling pressure on the pound pushed up interest rates on the inter bank market and the key one month rate remained above 6 per cent for the second successive day. If sustained, this would force the banks and building societies to raise rates for borrowers.
An early increase in interest rates is still seen as unlikely by most market commentators. Mr Mick Osborne, treasurer at First National Building Society, said that he saw no immediate pressure's. However. if interbank rates remained at their current levels for a few weeks, the pressure would be on for a rise.
Mr Jim Power, chief economist at Bank of Ireland, said that the Central Bank was sending a message that it was concerned about the inflationary consequences of the lower exchange rate.
There is a growing belief in the markets that the rate at which the pound enters EMU will be well below its recent levels. This speculation was fuelled by a comment from Mr Quinn just two weeks ago that he would prefer to see the pound move down towards these central levels.
Despite the large falls, the pound is still the strongest currency in the ERM grid, albeit only Just over 7 per cent stronger than the French franc compared to about 12 per cent a few weeks ago.