Markets still sceptical on beleaguered franc

PAUL WALLACE

Economics Editor

A rise in interest rates of over 1 per cent by the Banque de France brought respite to the beleaguered French franc. But the foreign exchange markets remained sceptical about the ability and commitment of the French government to sustain a prolonged defence of the franc with higher interest rates.

After falling to 3.53DM in early trading, the franc recovered to 3.51 after the French central bank raised its overnight rate from 6.15 to 7.25 per cent. Three-month rates rose to 7.40 per cent from 6.375 per cent.

The Bundesbank's president, Hans Tietmeyer, said "today's decision from the Bank of France will help to overcome the recent uncertainties in the currency markets."

The French finance minister, Jean Arthuis, strove to convince the markets about the underlying strengths of the French economy. Speaking in Washington at the annual IMF meeting, he said the outlook for competitiveness, inflation and growth was good, and the government deficit was on a downward path.

However, in London's foreign exchange markets there remained big question marks about the sustainability of French economic policy. The Banque de France strategy of raising interest rates was seen as offering only short- term support."This is only a holding measure in the hope the problem goes away," said Kit Juckes, currency strategist at NatWest Markets. "The French economy is in no shape to survive a protracted period of higher interest rates."

"I don't think it will hold the line," said Paul Mortimer-Lee, chief economist at Paribas Capital Markets. "We're in for a further period of pressure in which you could see the franc falling to 3.60 or 3.65."

The doubts in the currency markets about the French rate rise stem from a widespread belief that France has incompatible policy objectives. On the one hand it wants to cut the budget deficit in order to meet the Maastricht convergence criteria for monetary union. On the other, it wants to reduce unemployment, which President Chirac described as his "priority of priorities" in the election campaign.

The trouble is that as the government reduces the budget deficit, so it needs to ease monetary policy in order to bolster economic activity and increase jobs. This leads to the conclusion that the central bank will not be able to defend the currency through higher interest rates for long.