Pound gains over deutschmark as speculation grows

The pound has risen strongly against the deutschmark on international markets as overseas investors continue to speculate about the future of the currency. It breached the DM2.70 barrier as the markets build up to this weekend's meeting of EU finance ministers in Luxembourg.

Speculation has been rife in recent months that the pound's central rate in the ERM will be revalued. This move would be designed to prepare the way for entry to monetary union. At the moment its central ERM rate is DM2.41, almost 30 pfennigs below its trading level on the market, which is posing a problem for the Irish authorities as it becomes more likely that central ERM rates will be used to set the exchange rates for currencies entering monetary union.

The pound rose by almost a pfennig to DM2.7036. This leaves it almost 12.5 per cent above the weakest currency in the ERM band - the French franc - and well apart from all the other currencies in the band. Against sterling, the pound edged down slightly to close at 93.92p. International investors have been speculating for some time that the pound's central ERM rate may be revalued upwards. This speculation was fuelled by recent comments from the Bundesbank president, Dr Hans Tietmeyer, who said that a "single currency" - taken to be the pound - could be revalued as part of the move towards monetary union.

Buying of the currency has built up in recent days as international investors cover themselves against the possibility of a revaluation at this weekend's meeting of EU finance ministers (Ecofin).

However, market sources believe that such an early move is unlikely and warn that this could in turn lead to selling pressure next week. Analysts in Dublin believe the pound is overvalued at its current level and could face selling pressure. On balance, it appears unlikely that EU finance ministers will avoid a decision this weekend on the mechanism for setting exchange rates moving into monetary union. If they reach no decision, there will be no pressure on the Government for an early revaluation. But even if there are informal indications from the Ecofin meeting that central rates will be used to convert exchange rates, this could build pressure on the Government and the Central Bank to clarify their position. Dr Tietmeyer has hinted that he favours central ERM rates being used in the conversion process.

However, if there is no mention of conversion rates at the meeting, some analysts are forecasting a sharp fall in the pound on Monday morning as investors unwind the positions they have built up this week. And, even if the pound's central rate was revalued by 4 to 5 per cent, this would only bring it to just over DM2.50, still well below the rate at which it is currently valued on the markets.

The Government and the Central Bank will prefer not to be pushed into an early decision, as by doing so they could leave the pound vulnerable in the long run up to the final locking of currencies, due on January 1st, 1999. There could be particular problems if sterling were to fall sharply on the markets, leaving the pound looking overvalued and subject to speculative attack.