View from City Road: The French must look to Buba

Nemesis unhappily follows hubris, even for the French. Three weeks ago the French authorities hailed the franc as a rival for the German mark's anchor role in the exchange rate mechanism, but now the currency is in danger of being forced out of the system altogether.

The French authorities face the same predicament as the British a year ago. Despite 10 interest rate cuts since the Balladur government came to power, rates clearly need to fall further and faster if the economy is to stabilise.

This makes interest rate increases a doubtful weapon for defending the currency. By further deepening the recession, higher rates might do the franc more harm than good by shortening the odds on an eventual devaluation. The markets think that French rates have to fall - if not inside the ERM, then outside.

The franc's predicament has been worsened by a lifting in Germany's economic gloom. The Bundesbank has argued that the economy may be 'bottoming out' and it is thought unlikely to cut its rates again until the autumn. But the franc should not be written off yet. Unlike sterling last year, the franc has the advantage of the Bundesbank's unambiguous support. And that counts for a lot.

The Bundesbank covertly intervened in the franc's support late last week, and yesterday morning made that support public. Significantly it openly bought francs for marks while the French currency was still well above its ERM floor, earlier than it intervened last year in support of the pound. But, as the events of last September showed, support buying of an ERM currency might have to be so massive as to pump cash into the money markets, and reduce interest rates.

So it is the Bundesbank council's willingness to cut interest rates again this Thursday that will determine the fate of the franc. The key discount rate is unlikely to be cut, but some sign of flexibility on 'repo' rates is the least the Buba can do.