Strong gains by sterling posing policy dilemma for the Central Bank

STERLING has gained strongly on the international currency markets and the pound has fallen close to 99p. The continued rise of the British currency has also pulled the pound higher against Continental EU currencies.

While officially the Dublin market was closed yesterday, the pound traded at above DM2.60 and is now by far the strongest currency in the ERM band.

The continued strength of sterling on the foreign exchange markets is posing a dilemma for the Central Bank. It will be concerned that too sharp a fall by the pound against sterling could push up inflation by increasing import prices.

However, intervening to support the pound by buying it on the markets pushes it even higher against the other ERM currencies. Already the pound is at the top of the band, more than 7.5 per cent above the deutschmark. To underline the pound's qualifications to participate in the single currency, the bank would prefer a tighter trading range, against the other ERM currencies.

There was some dealing in the pound in Dublin yesterday, with dealers reporting some corporate demand for the currency, probably related to year end adjustment of company books.

In London, sterling was up sharply to DM2.6314 against DM2.6040 on the Tuesday evening, before the holiday.

"The market is still marked by favourable sentiment on sterling," said Mr Chris Turner, an analyst at Barclays de Zoete Wedd. "That has been the case since the emergence of renewed optimism about a rise in British interest rates in the wake of statement by Bank of England governor, Mr Eddie George, calling for tighter British monetary policy."

Mr George said on Tuesday, in an interview with a French newspaper, that to "contain" the strong growth of the British money supply, it will be necessary some time to raise interest rates, and that might occur before next May.

Dealers in Dublin believe that continued speculation about higher British interest rates will maintain sterling's strength on the markets. They said that the pound could slip below 99p sterling early next week, given the recent strength of the British currency.

The Central Bank could choose to intervene to support the pound, but it is not clear how seriously it judges the inflationary risk with the pound falling against sterling but rising against the continental EU currencies.

Sterling is now at its strongest level against the deutschmark since Black Wednesday - the day it dropped out of the ERM in September 1992. The pound also at its highest level against the deutschmark since the currency crisis and is now less than two pfennigs below the floor in the old ERM band of DM2.6180 before the January 1993 devaluation.

Meanwhile, yesterday the dollar moved above 115 yen tore European trading began continued to firm gently during the day. It reached around 115.55 yen late in the day as turnover dried to a trickle with traders leaving their desks early for the weekend.

It was its first rise to such levels since April 1993 and came after the Japanese currency took a beating after stock prices tumbled in Tokyo this week. However, the Japanese market recovered yesterday.