Mary R. McCarthy *
The past year has been an eventful one for the EMS, in particular for the currencies which are members of the ERM. The tensions which had been evident in the system, to a greater or lesser extent, since the crisis of September 1992 continued to prevail early in 1993. The system witnessed another realignment at the end of January 1993, when the Irish punt was devalued by 10%. After the easing of pressures on the French franc in March, once the general elections were over and new government had taken up office in France, a period of relative calm ensued. This uneasy peace within the system was broken once again in May with the 8% devaluation of the Spanish peseta and the concomitant 6.5% devaluation of the Portuguese escudo. The situation came to a head in July, when a number of ERM currencies became the simultaneous focus of severe/unprecedented speculative pressures .
The decision to widen the ERM bands to +/-15%, taken by
the EC ministers and the central bank governors on 2 August 1993, relieved
much of this pressure. However, some currencies continued to be subjected
to downward pressure in August and it was not until September/October,
when markets became more convinced that monetary authorities were not going
to use the leeway granted to them by the widening of the bands to rapidly
cut official interest rates, that tensions really appeared to dissolve.
Since then, those currencies which had through depreciation moved outside
their old ERM limits, have been effecting a return to pre-band-enlargement
levels. The non-ERM member currencies of the EMS did not remain isolated
from ERM tensions and movements in these currencies were also influenced
by political and economic events in their respective countries. What follows
below is a broad outline of the chronology of events which characterised
the EMS in 1993; it should not be viewed as a detailed or exhaustive description
of these events.
As trading volumes returned to normal after the holiday period, the ERM was subjected to a renewed bout of pressure during the first week in January. Although the DM weakened against the USD, amid rumours of an easing of German monetary policy, the FF slipped to 3.42 per DM despite concerted intervention by the Bundesbank and the Banque de France (BdF). Other attempts to curtail speculative pressure include: a suspension by the BdF of its five-to-ten day rate of 10% and its replacement by an overnight facility of 12%; and a joint communiqué by the French and German governments and central banks confirming their commitment to the existing ERM parity. The decision by the Bundesbank to lower its repo rate by 15 bps to 8.6% on 7 January relieved pressure on the FF, which reached a six-week high of 3.389 per DM on 13 January; the currency was also supported by high short-term rates, the key intervention rate remaining unchanged at 9.10%.
The IRL also came under heavy pressure in early January,
requiring marginal intervention support from the Dutch and Belgian central
banks; the Central Bank of Ireland (CBI) raised its marginal overnight
borrowing rate from 10% to 50% on 6 January. Pressure on the currency,
which had intensified despite official denials of rumours of rumours of
a weakening of the Irish authorities' resolve to defend the central parity,
were reduced somewhat after the CBI hiked its overnight rate (8 January)
from 50% to 100%. However, under pressure to prevent this high rate from
being transmitted to retail rates, the CBI lowered the overnight first
to 30% and later to 15% during the following week and the punt traded close
to its floor again. Tensions heighteneded once more in the last week in
January. Outside the ERM, sterling fell by 7 pfennig to DM 2.39 after the
Bank of England (BoE) cut its base rate (26 January) by one percentage
point to 6%, the lowest level in 15 years. The IRL fell sharply as sterling
weakened and as the currency fell close to its ERM floor against the BLF,
the CBI raised the overnight rate to 100%; on 29 January the two main commercial
banks in Ireland raised their base rates to 28% and intervention in support
of the punt was reported by the Belgian National Bank (BNB). The FF and
DKR also suffered from speculative fallout within the ERM. On 30 January,
the ministers and central bank governors of the EC Member States announced
a 10% devaluation of the Irish punt, with effect from 1 February and the
CBI reduced its overnight lending rate to 14%, also with effect from 1
With the IRL trading just above its new central parity of DM 2.41105, the CBI reinstated its short-term lending facility at 13.75% on 5 February. The focus of speculation shifted to the DKR, which reached its floor against the IRL on 3 February. Danemarks Nationalbank raised its 14-day certificates of deposit rate by 150 bps to 13% (3 February) and its official discount rate by two percentage points to 11.5% (4 February) and the DKR was supported by the co-ordinated intervention of five EC central banks (of Belgium, Denmark, France, Germany and the Netherlands). On 4 February, the Bundesbank cut its Lombard rate by 50 bps to 9% and its discount rate by 25 bps to 8%, followed by central rate cuts of 10 bps by the Nederlandsche Bank and the Belgian National Bank. Pressure on the DKR eased and the currency strengthened to 3.84 per DM compared to its floor of 3.9016 per DM. The FF remained steady around 3.38 per DM despite a move by the BdF to shave 12.5 bps from the overnight rate, bringing the rate to 11.5% (8 February); but the BLF slipped below its central rate of 20.6255 per DM and the BNB raised its end-of-day rate by 50 bps to 9.3%.
The third and final weeks in February saw some speculative pressure on the PTA and ESC. Following a 25-basis-point cut in the ten-day repurchase rate on 12 February and derailed by news that the unemployment rate in Spain had risen to over 20%, the PTA tumbled from the top of the ERM grid to just 2.7% above the bottom-placed FF; the Banco de España raised its average daily money market intervention rate from 13% to 15% on 15 February. After a temporary respite, the peseta weakened once more amid rumours that political parties in opposition favoured a devaluation of the currency. An official statement by the Spanish Prime Minister failed to halt the decline of the peseta, which fell through its central parity of 72.7877 per DM despite overnight rates at 20%. The currency finally recovered to 71.6 per DM on 26 February, following discrete intervention by the Banca de España and helped by a weakening of the IRL. The ESC weakened along with the PTA and the Banco de Portugal raised its regular absorption rate by 25 bps to 13% on 15 February, having reduced it by the same amount earlier in February. Encouraged by the strength of the DKR, Danemarks Nationalbank cut its official discount rate by one percentage point to 10.5% on 22 February.
Outside the ERM, the lira remained largely unaffected
by a 50-basis-point cut in its discount and Lombard rates to 11.5% and
12.5%, respectively, on 3 February. However, the lira had fallen from LIT
932 per DM on 12 February to LIT 984 on 24 February -- a loss of over 5.5%
in less than two weeks -- against a background of deepening political worries
related to the investigation on corruption charges of major figures in
the Italian political and business fields. Sterling weakened progressively
over the month, amid concern over the state of the UK economy and expectations
of further base rate cuts; the currency recovered some ground following
statements by Chancellor Lamont saying there was no room for an official
rate cut, but by 24 February, sterling had reached an historical low of
On 5 March, the Bundesbank's cut in its fixed repo rate from 8.49% to 8.25% came as a surprise to the markets, leading some ERM currencies to strengthen vis-à-vis the DM. Sterling, which had already recovered sharply to DM 2.37 (1 March) on stronger-than-expected money supply growth figures, strengthened further to DM 2.40; and the lira was initially boosted to LIT 950 per DM, before falling to 971 when a ministerial resignation and the blocking of a decree law to decriminalize violations of political party financing laws threatened to destabilize PM Amato's coalition Government. In line with widely-held expectations, the Belgian and Dutch central banks cut their discount rates by 25 bps to 7.25% on 10 March. The Danish central bank reduced its 14-day certificate of deposit rate in two 50-basis-point cuts (3 and 10 March) to 11.5%; the DKR traded steadily around 3.834 per DM. The ESC weakened amid rumours that the currency was about to leave the ERM and that the Central Bank Governor had resigned; despite intervention to support the currency and a rise of 50 bps in the liquidity absorption rate to 13.5% on 12 March, the ESC slid through its central rate to trade at 94 per DM; the continued weakness of the currency led the Banco de Portugal to raise its liquidity absorption rate by 450 bps to 18% on 19 March.
At its regular Council meeting on 18 March, the Bundesbank
cut its discount rate by 50 bps to 7.5%, leaving the Lombard rate unchanged
at 9% and its repo rate unaltered at 8.25%. The Belgian, Dutch and Danish
central banks followed suit. The IRL strengthened along with sterling,
which was boosted from DM 2.40 to 2.44, following news that UK unemployment
had fallen in February. The CBI cut 75 bps off both its short-term facility
and overnight deposit rates to 10.75% and 7.5% respectively, on 19 March.
The FF remained weak, trading at 3.41 per DM ahead of the first round of
General Assembly elections (21 March), which raised doubts in the markets
about the continuation of the "franc fort" policy under a new government;
after approaching its lower limit against the IRL on 26 March, the FF strenghtened
to 3.39 per DM after the election victory of the centre right coalition
on 28 March. The BNB raised its central rate by 50 bps to 8.5% and its
emergency lending rate from 9.75% to 12.5% on 24 March, after the BLF had
come under pressure when the Belgian government offered its resignation
after having failed to agree on measures to reduce the budget deficit.
On 30 March, the Belgian government approved a fiscal package to reduce
the deficit in 1993-4 and as the currency had recovered lost ground and
the BNB was able to reduce official rates once again.
The lira, which had continued to weaken in March amid reports of a projected overshoot in the Italian 1993 budget deficit and an escalation of political scandals undermining the Amato Government, hit an historical low of 1004.25 per DM on 2 April. Shortly thereafter, the currency moved into an upward correction, helped by anticipations of support for positive changes in the political system in the referendum of 17 April; the lira had strengthened to 958 per DM by 20 April. The PTA was also undermined by political worries in the form of a corruption scandal surrounding the ruling socialist party. Following the announcement on 13 April of an early general election for 6 June, the peseta yielded its place at the top of the grid to the IRL. The escudo also weakened, falling through its central parity and prompting intervention to support the currency by the Banco de Portugal. The FF staged a recovery, helped by the new French government's strong reaffirmation of the "franc fort" policy; it was trading 3.382 per DM by 13 April, despite a 200-basis-point cut to 10% in the five-to-ten day repo rate; the currency's firmness prompted further official rate cuts on 19 April, including a 35-basis-point reduction in the intervention rate to 8.75%.
On 22 April, the Bundesbank cut the Lombard rate by 50 bps to 8.5% and the discount rate by 25 bps to 7.25%. This move was followed by official rate cuts in Belgium, Denmark, France, Ireland, Italy and the Netherlands; the CBI having already reduced its short-term facility rate on 19 April. On the other hand, the peseta's continued weakness led the Banca de España to raise its daily intervention rate from 13.35% to 14% on 22 April. Concerted intra-marginal intervention by all narrow band central banks to support the currency took place on 23 April, after the peseta fell to 74 per DM and to the bottom of the grid amid rumours of a possible devaluation or float of the currency; and the daily intervention was raised to 15%. With rumours of a serious depletion of Spanish foreign currency reserves rife in the markets, heavy selling pressures on the peseta continued until 28 April, when pressures eased somewhat following a 34-basis-point cut in the German repo rate to 7.75% and comments from a Bundesbank Council member implying that there was no economic reason for a change in the central parity of the peseta. The ESC, which had weakened along with the PTA, also recovered some ground.
Outside the ERM, the lira jumped from 930 to 924 per DM
after Ciampi's appointment as prime minister on 26 April but fell to 947
on 30 April on the resignation of four ministers in the newly-formed government
following news that the parliament had blocked a corruption probe on Mr.
Craxi. During the month, sterling benefited from stronger-than-anticipated
signs of an upturn in the UK economy; the currency breached DM 2.50 by
26 April but retreated to DM 2.48 by the end of the month.
During the second week of May, speculative pressures built up once more against the Spanish peseta, with markets anticipating a devaluation following the Spanish general election. On 13 May, the Banca de España temporarily suspended its ERM intervention obligations and requested a devaluation at a regular meeting of the Monetary Committee. The Banco de Portugal followed suit. Both currencies plunged, the peseta to 75.70 per DM and the escudo to 97 per DM. Later the same day, the ministers and central bank governors of the EC Member States announced an 8% devaluation of the PTA and a 6.5% devaluation of the ESC. Thereafter, On 14 May, the Banca de España lowered its key official interest rate by 150 bps to 11.5%, while the Banco de Portugal cut its regular absorption rate from 17% to 15%. Although the DKR was under some pressure, weakening to 3.86 per DM, in the period running up to the second Danish referendum on ratification of the Maastricht Treaty (18 May), it strengthened as confidence of a "yes" vote grew. The currency was steady at 3.83 per DM on 19 May after Danemarks Nationalbank cut the official discount and key deposit rates by 100 bps to 8.25% in the wake of a 56.8% "yes" vote.
After the devaluation, the PTA and ESC had moved to the
top of the ERM grid once again. However, while the ESC retained its strength
despite official rate cuts, the PTA was weakened by pre-election jitters
- doubts about the commitment to the ERM opposition among the opposition
parties in Spain - and official interest rate cuts. The peseta had plunged
to fifth place in the grid by 27 May, at a level just above its new central
parity of 79.1172 per DM. Outside the ERM, sterling fell 3 pfennig to DM
2.48 as expectation of a cut in official interest rates grew following
news that Kenneth Clarke had replaced Norman Lamont as Chancellor.
Although the peseta had enjoyed a calmer period, trading just above its central parity, immediately before the general elections, it moved to the top of the grid once again on 7 June following the Socialist Party's victory in the general elections. All currencies in the ERM benefited from the weakness of the DM during this period. The currency was undermined by indications of a deterioration in the German economy. The DM's ERM divergence indicator had slipped from -16 on 11 June to -30 on 22 June, despite statements by Bundesbank officials on their determination to preserve the stability of the DM and no changes in official interest rates. Despite the latter, official rate reductions took place in many ERM countries and negative three-month interest rate differentials vis-à-vis Germany were evident in all narrow band countries except Denmark. However, a regular meeting of the Franco-German Economic and Finance Council was cancelled on 24 June after the French minister of economics had raised the possibility of discussing concerted interest rate cuts.
Outside the ERM, the lira continued its appreciating trend
amid growing confidence on reaching a national labour accord. Sterling
rose from DM 2.52 to DM 2.54 (30 June) as speculation of a near-term cut
in official interest rates receded.
After the slim one-basis-point cut to 7.58% in the German repo rate on 30 June, the Bundesbank's 50-basis-point reduction in the discount rate to 6.75% and its 25-basis-point cut in the Lombard rate to 8.25% on 1 July came as a surprise. Official and/or key money market rates were adjusted accordingly in Belgium, Denmark, France, Ireland, Italy, the Netherlands, Portugal and Spain. By 9 July, the DM's divergence indicator had reached +10, compared to -14 on 7 July, as the currency strengthened amid dwindling hopes of a further official rate cut before the summer recess.
At the same time, the French franc was undermined by a rising tide of grim economic news. On 9 July, the FF broke through 3.40 per DM for the first time in over three months and its divergence indicator reached -71, despite French and German official statements in support of the currency. Apart from the HFL, all other ERM currencies suffered from the tensions affecting the FF. Outside the ERM, the lira, which had strengthened to 901 per DM on 5 July on the strength of the weekend's wage bargaining agreement, was also affected; it fell to 912 per DM. Meanwhile, sterling strengthened to DM 2.56 on 12 July and reached a peak of DM 2.59 on 26 July, benefiting from safe-haven buying and encouraging domestic economic indicators. The speculative assault on the FF continued; it reached 3.4185 on 14 July despite intervention by the French and German central banks. In a similar manner, the DKR fell to its ERM floor in spite of Danish official "no-devaluation" statements, entailing concerted ERM central bank marginal intervention on 16 July; the central parity was also supported by a 200-basis-point hike in Danish official discount and deposit rates to 9.25% and an offer of liquidity to the market at 20% on 19 July. The Banque de France suspended its five-to-ten day lending facility on 22 July, replacing it with a one-day facility at 7.25%, which it subsequently increased to 10%. A joint communiqué by the French and German governments and central banks expressing satisfaction for the FF-DM parity was issues on 23 July. On the same day, pressure on the BLF led the BNB to raise its three key interest rates. However, the BLF fell to 20.78 per DM and the three official rates were raised once again on 26 July. During this period, the PTA and ESC also came under heavy selling pressure; both currencies weakened to the lower half of their fluctuation bands against the DM and fell from the top of the grid on 22 July. A 250-basis-point hike in the Banco de Portugal's overnight credit facility rate on 26 July did little to alter the escudo's weakness.
ERM tensions eased somewhat on 28 July when the Bundesbank's
20-basis-point reduction in its two-week repo rate created expectations
of further official rate cuts on the following day. However, on 29 July,
the Bundesbank cut the Lombard rate by 50 bps to 7.75%, leaving the discount
rate unchanged at 6.75%. Despite a 25-basis-point reduction in Dutch official
rates, the BLF, DKR, FF, ESC and PTA all underwent severe speculative attacks
and massive intervention by ERM central banks was carried out on 29-30
July in order to keep these currencies at or above their ERM floors. The
BNB raised its three key official rates by one percentage point to support
On 2 August, following a meeting in Brussels, the EC ministers and central bank governors announced a temporary widening of the ERM fluctuation margins to +/-15%; they saw no reason for a change in central rates, which were considered to be in line with economic fundamentals. Germany and the Netherlands decided bilaterally to maintain a fluctuation band of +/- 2.25% between the DM and HFL.
On 3 August, the Bundesbank lowered its two-week repo rate by 15 bps to 6.8%. During August, the BLF, DKR, FF and IRL, all former narrow-band currencies, moved outside their old ERM bands, while the PTA and ESC remained inside their old +/-6% limits. The FF fell from 3.49 per DM on 2 August to a low of 3.545 on 16 August, before recovering to 3.495 on 30 August (4.2% below its central parity). Although French monetary authorities reinstated the five-to-ten day repurchase facility on 6 August at 10%, they adjusted neither this rate nor the intervention rate; rather, they reduced the overnight lending rate (introduced on 22 July) in five steps from 10% to 7.75%, before suspending it on 23 August.
The BLF rarely strengthened above 21.0 per DM during the month; it was undermined in late August by a manifesto from some Belgian economists urging a discontinuation of the policy of closely linking the BLF to the DM. From 4.0 per DM on 2 August, the DKR weakened to 4.11 by the end of the month, over 7% below its central parity. The IRL fell below its old 2.25% floor on 10 August amid uncertainty about the direction of the CBI's foreign exchange rate policy and was trading at over 3% below its central parity by the end of the month. Although the PTA and ESC both weakened, they remained within -4% of their respective central parities.
Outside the ERM, both the lira and sterling depreciated
during August, the former by 2.5% and the latter by 3%.
On 2 September, the BNB hiked all of its official rates by one percentage point, bringing the discount rate to 7%, the central rate to 10.5% and the emergency lending rate to 14%. However, despite this move, the BLF remained weak at 21.5 per DM. On 9 September, the Bundesbank lowered its discount and Lombard rates by 50 bps to 6.25% and 7.25%, respectively, and announced a 10-basis-point cut in the repo rate to 6.7%. Several other EC central banks followed with official rate cuts, including the central banks of Belgium, France, Italy and the Netherlands. Contrary to the usual response of a currency to interest rate cuts, these moves were followed by a strengthening of both the BLF and FF. The following weeks witnessed a further easing of tensions in the ERM, with official interest rate cuts in Belgium (13, 15, 16 and 20 September), Denmark (16 and 27 September) and Portugal (13 September) being followed by a strengthening of these currencies vis-à-vis the DM. This trend was also encouraged by worries over the political situation in Russia, which weakened the DM.
Towards the end of the month, the BLF weakened marginally
to 21.55 per DM on 30 September after the BNB shaved 10 bps off its central
and end-of-day rates; markets were nervous due to difficulties encountered
in the social pact negotiations in Belgium and rumours that Luxembourg
was about to sever its currency peg to the BLF, despite denials by the
Luxembourg authorities. Outside the ERM, both the lira and sterling continued
to lose ground; at the end of the month, the lira had fallen to 975 per
DM and sterling was trading at DM 2.45.
Both the FF and BLF were subjected to speculative pressure, resulting from market expectations that the economic situation in both countries would result in official interest rate cuts in the near-term. Following the German Constitutional Court's decision on 12 October allowing ratification of the Treaty on European Union, the DM appreciated vis-à-vis many ERM currencies. Pressures on the FF and BLF intensified: the FF hit a low of 3.545 per DM on 15 October, while the BLF reached 22.06 per DM on 14 October despite intervention by the BNB. Although tensions had eased somewhat during the third week of October, the Bundesbank's decision on 20 October to lower its discount and Lombard rates by 50 bps to 5.75% and 6.75%, respectively, relieved pressure further. The move was followed by official rate cuts in Belgium, Denmark, France, Ireland, Italy and the Netherlands. All ERM currencies strengthened in the wake of this round of reductions, although the BLF was adversely affected by the collapse of the social pact negotiations and the FF suffered from the presence of domestic social unrest. The escudo remained stable despite the reintroduction on 26 October of absorption and liquidity supply rates suspended on 26 July and a 50-basis-point reduction in the discount rate to 13% on 29 October.
Outside the ERM, the lira weakened at the end of the month
as political discussion delayed voting on the 1994 budget; in the UK, positive
economic indicators and the absence of an official rate cut boosted sterling
from DM 2.45 in the middle of the month to DM 2.49 by its end.
Early in the month, the DM weakened against several EMS currencies as investors weighed up the implications of the continuing weakness in the German economy. However, the Iberian currencies suffered vis-à-vis the DM; in particular, the peseta weakened to 80.78 per DM on 11 November and to 81.3 per DM on 15 November in response to rising unemployment and higher-than-expected inflation in Spain. Later in the month, the PTA was further undermined by threats of a general strike in Spain in a gesture of opposition to the Government's social pact proposals. Following the agreement by the Belgian government on an austerity package, the BNB cut its official rates on 17 November. The BLF benefited from positive market sentiment which took the currency to 21.15 per DM on 17 November.
Outside the ERM, sterling continued its appreciating trend,
breaching the DM 2.51 level on 3 November and the DM 2.52 level on 16 November;
the currency's gains were extended further to DM 2.54 following a 50-basis-point
cut in the minimum lending rate to 5.5% on 23 November. The lira, on the
other hand, continued to be weighed down by domestic political problems;
it hit an historic low of 1005 per DM on 23 November following the first
round of local elections in Italy, before recovering to 995 by the end
of the month.
On 2 December, the Bundesbank announced a fixed repo rate at 6%, 25 bps lower than previously. Official interest rates were cut in Belgium and the Netherlands and intervention rates were reduced in France and Spain. Thereafter, other ERM currencies began to gain on the DM, reducing the spread in the ERM grid. By 3 December, the BLF had breached 21.095 per DM, its former narrow band lower limit; by the end of the month the currency was trading steadily at 20.81 per DM, despite official interest rate cuts on 22 and 28 December. The FF broke through its former lower threshold of 3.4305 per DM on 9 December and was trading at 3.398 per DM by the end of the month. The DKR continued its appreciating trend which had been in evidence since September; having pushed its way through its former narrow band floor of 3.9016 per DM on 10 December, it retreated slightly before breaching the threshold once again on 29 December. The peseta has maintained its position at the bottom of the grid since the start of the month; the currency remained weak during December, undermined by the Banesto crisis which emerged on 28 December and the threat of social unrest looming in the New Year; it was trading at 82.10 per DM by the end of the month. The escudo, standing second from the bottom of the grid, reacted little to two cuts in the regular intervention rates of the Banco de Portugal and was trading at 101.8 per DM by the end of the month.
Outside the ERM, the lira, having reached a historic low
of 1010 per DM ahead of the second round of local elections at the beginning
of the month, had recovered to 987 per DM by the end of the month. Sterling
sprinted ahead to DM 2.56 on 3 December as the markets responded positively
to the UK budget; expectations of official rates cuts undermined the currency
thereafter but it had rallied once again to DM 2.56 by the end of the month.