Currency policy wants to see which way sterling jumps

RECENT turbulence in the foreign exchange markets has prompted some serious rethinking at the Department of Finance.

Worried that a further speculative attack could drive the currency down too far, too fast and hence drive up inflation, the Department has been carefully examining its choices.

The simple option of raising interest rates again in the face of renewed selling pressure is unpopular. It would also leave rates with further to fall when we do actually join the single currency and would be very unpopular with the electorate.

Another option, which has been looked at with some seriousness, is a revaluation of the pound in the Exchange Rate Mechanism.

Whether this is ever likely to happen is a moot point. It seems likely that by even talking about it officials are hoping to obviate the need to do anything.

Nevertheless, it is not an option which can be completely ruled out. The authorities are said to believe increasingly that it would be in Ireland's best interest to join the single currency around 2.55 deutschmarks, rather than our current central rate of DM2.41.

The theory is that given the long term prospects for the economy for growth of around 5 per cent a year for at least 10 years as outlined by the ESRI last week and our balance of payments surplus, we could comfortably trade at a constant rate significantly higher than the current central rate.

Officials at the Central Bank are said to be most vocal in support of the idea. While they have been advising up to now, it would be the mandarins at Merrion Street who would make the call.

For them, the most obvious danger in making a preemptive move is that no one is sure where sterling is likely to trade against the deutschmark at the end of this year and into next year. If it were to fall significantly we could have given a hostage to fortune in driving up the central rate.

Prominent London economist Mr Avinash Persaud of JP Morgan has predicted that sterling would fall to levels around DM2.68 to DM2.71 before the new Chancellor of the Exchequer, Mr Gordon Brown's mini Budget in July.

If this were to happen it would reduce the pressure on the authorities here - the inflation danger would be reduced and the pound could trade higher against sterling without gaining significantly on the deutschmark, cancelling the need for a revaluation.

A revaluation of the pound would also prove politically difficult. The farmers and exporters have welcomed the falls in the pound so far but are calling for more. The Minister is very unlikely to want this ahead of a general election.

Despite this, the authorities may be keen to negotiate a new central rate which could then be brought quickly into play if the currency were to come under renewed and sustained speculative attack.

This would deter the speculators as they would no longer have a low target for the pound where profits are practically guaranteed. A central rate around DM2.50 would also leave little room for further falls in the pound.

The technical arguments against this have apparently already been looked into. There were fears that in terms of the stability and exchange rate criteria a revaluation could mean failing the Maastricht criteria for joining. It now appears that this may not be the case.

The argument also presupposes that central rates will be used as the locking in level for currencies joining the euro. This has not been formally decided and has not been discussed at the monetary committee or at the council of the European Monetary Institute, the forerunner of the European Central Bank.

Nevertheless, there is a growing belief in the markets that this would be the favoured option. French officials, in particular, have been talking about using the central rates. The Italians and Germans are also said not be to be adverse to the idea. Mr Alexander Lamfaloussy, president of the EMI, was said to be in favour of average rates over 12 months. However, he is leaving the post in July and the views of the likely new man are not clear.

At the end of the day, the authorities' preferred option would be to wait and see. If sterling falls many of the problems would fade away and a gradual fall against the deutschmark even to our currency central rate - may still be possible. Only a very sustained attack is likely to force any decision.