SPECULATION is growing that Irish interest rates may fall by as much as half a percentage point to keep the pound within its limits in the Exchange Rate Mechanism.
Yesterday, as sterling soared on currency markets, the pound rose further against other ERM currencies and closed 11.6 per cent above the weakest currency in the grid, the French franc.
Maastricht guidelines allow a maximum deviation of 15 per cent between the strongest and weakest currencies in the ERM and there is a growing belief that, despite the wishes of the Central Bank, interest rates may fall to prevent a continued rise in the value of the pound.
NCB economist Dermot O'Brien believes money market rates will fall from 53/4 per cent to 5 per cent within the next six months, enough to trigger a half per cent fall in bank lending and mortgage interest rates. "Money market rates have softened noticeably in the last few days. We're at a stage now in the ERM where something has to give. The only weapon the Central Bank has is to sell the pound and put money into the interbank market, and that puts downward pressure on rates.
Mr O'Brien added that NCB believes the German Bundesbank will soon cut its key interest rates in an effort to kickstart the stagnant German economy and that this could "telescope the process" of the pound rising towards its ERM ceiling.
Even though the pound closed at its lowest level for four years against sterling at 97.30p, it still closed up over 1.5 pfennigs against the German mark at DM2.67 while sterling itself closed on DM2.74. "This is entirely a sterling-driven phenomenon, but is creating serious problems for the Central Bank, which wants a rate cut like a hole in the head," said one dealer.
Money market rates are the main influence on retail interest rates and a one-month interbank rate of 5 1/2 per cent is seen as a level where fixed interest mortgages might fall - possibly to under 7 per cent. Yesterday, one month money fell to under 5 3/4 per cent despite reported selling of the pound by the Central Bank in an effort to keep rates up.
Bank of Ireland economist Jim Powers said he believed sterling would continue to strengthen and reach DM2.80 to DM2.85 against the "very sick" German mark. This would put the Irish pound 13.5 per cent higher than the weakest ERM currency. "Under normal circumstances there is no way anybody would consider a rate cut when the economy is so strong and has got a recent fiscal boost from the budget, but interest rate sentiment is going more positive."
"If the mark continues to weaken, then there is a real possibility of lower retail rates," he said. Asked if the Central Bank could prevent individual banks cutting rates if money market rates fall far enough, Mr Power said: "Probably not."
Riada Stockbrokers Dr Dan McLaughlin said: "Our view is that we could see the pound reaching the 15 per cent ERM limit unless something is done about the exchange rate."
Dr McLaughlin also warned that doubts about EMU and the ability of some of the key economies - and Germany in particular - to satisfy EMU requirements are beginning to circulate in the markets. "The German economy is in dire straits, but they can't lower taxes because of their budget deficit."
Dr McLaughlin did not agree, however, that money market rates would fall to 5 per cent and added that such a fall would require sizeable buying of the pound by overseas investors.
Sterling closed at its highest level for a year against the mark yesterday, largely on the basis of a report that rising German unemployment had pushed Germany's budget deficit to 3.5 per cent of GDP, above the Maastricht 3 per cent ceiling.