THE collapse of the single currency would have a positive effect on inflation, thus reducing the need to increase interest rates, according to Mr Jim O'Leary, chief economist for Davy Stockbrokers.

In his latest Weekly Market Monitor, Mr O'Leary argues that Irish exchange rate policy has been perverted by EMU and its collapse would clear the way for the pound returning to parity with sterling, while strengthening its position with the deutschmark.

This would reverse the losses the pound has sustained this year, improve the inflation rate for the next 12 to 18 months and avoid further interest rate increases.

Uncertainty over monetary union has increased after the new French socialist government adopted a period of reflection on the stability pact.

Mr O'Leary believes that the conventional wisdom - the sharp rise of the deutschmark and a pronounced divergence of interest rates between the rest of Europe and Germany surrounding the collapse of the EMU may be wrong. The weakness of the deutschmark is not down to concerns over its replacement with a weak euro, he says, but related to the weak performance of the German economy in relation to Britain and the US.

The conventional wisdom argues that Irish interest rates would rise sharply after the collapse of the single currency. Mr O'Leary points to the theory that signing up to the single currency on January 1st, 1999, would mean Irish interest rates would fall towards their German equivalents in the intervening period. Since interest rates have already been increased (May 1st) this year, and may do so again, this theory does not hold water, he insists.