Sterling sets tone as the pound falls back

The pound has fallen back close to 89p sterling and also eased against the deutschmark. However, it is not clear whether the upward pressure on the currency in the ERM band will resume again next week, with much depending on whether sterling again moves upwards on the markets.

The British currency failed to hold on to early gains yesterday and it was trading just below the key DM3 barrier late yesterday. Dealers said that the British currency appeared to be in a consolidation phase.

However, the pound still eased slightly against sterling, easing to close at 89.38p sterling, from 89.73p on Thursday. It also eased against the deutschmark to DM2.6822 from DM2.6899. The pound is now 12 per cent above the weakest currency in the ERM band - the French franc - having risen to almost 13 per cent above the franc earlier this week.

However, the tension in the ERM could heighten again on Monday, as market analysts warn that the French franc could weaken if the market is disappointed by the new government's audit of the public finances.

Forecasts of a high public deficit, well above the Maastricht 3 per cent ceiling, could hit the franc and leave the pound approaching its strongest possible limit against the French currency. Yesterday sterling was also affected by weakness of the US dollar. The US currency weakened on Friday due to profit-taking in the wake of the heights reached the previous few days. The US dollar was trading at DM1.7881 against DM1.7922 on Thursday evening in London, and to 115.39 yen against Y116.10.

"The dollar failed to maintain itself above DM1.80, so people took profits, so as to start next week off in a more neutral position," said Mr Martin De Blocq, a forex expert at Nomura bank. "Moreover, the foreign trade figures didn't help." The US trade deficit jumped 17.2 per cent in May, and the dollar's level may be blamed in part for the deterioration. Another negative factor for the dollar was Wall Street's drop yesterday.

Meanwhile, in Dublin speculation continued about the future of the pound and whether the Government should consider a revaluation of the currency's central ERM rate. Mr Kevin Daly, of Ulster Bank treasury, argued that "if an ERM revaluation was implemented now and sterling subsequently collapsed, Ireland could be left with an over-valued conversion rate to the euro".

However, Mr Daly says EU sources have been quoted as saying that ERM conversion rates may be decided in September. In this case the Government might be forced to re-value at that stage. He concludes that the best policy for the Government would be to delay a decision on revaluation for as long as possible.

Nevertheless, he warns that "there is a distinct possibility that further sterling appreciation or an early decision on the conversion rates may force Mr McCreevy's hand".

Meanwhile, Dr Dan McLaughlin, chief economist at Riada stockbrokers, argues that the pound's strength "is a sign that the economy is not suited for EMU entry near term" as it partly reflects the strong growth in the economy which is in contrast to economic conditions in continental Europe.