City: Sterling fall-out will hit shares

WITH Britain's sterling crisis showing no sign of abating, events seem to be turning from tragedy into farce. There was something ridiculous, even comic, about the spectacle of the German ambassador to London being summoned - 1939 style - to the Foreign Office for a formal ticking off over the Bundesbank's behaviour. The German central bank may have broken some quaint diplomatic convention by deliberately leaking a briefing document on its actions during the sterling crisis, but in truth its only purpose was to defend itself.

What's so wrong with that? If the unfolding crisis was not so serious, the whole thing would by now have become laughable.

Anyone would think we were about to fight the Second World War all over again. Some of the language used in the row over who is to blame for the pound's enforced withdrawal from the ERM certainly goes beyond that of recrimination. Both sides are in essence accusing each other of lying. Every time British ministers or their German counterparts attempt to cool the war of words, it breaks out afresh.

Nobody gains from battles like this. Norman Lamont's determination to argue the toss with the Bundesbank is understandable, but ultimately the only person the Chancellor discredits is himself. Whatever the underlying merits of his case, he has been made to look as disingenuous as Helmut Schlesinger, president of the Bundesbank. There is no question of him being caught lying. He has not. But as more becomes known about events leading up to Black Wednesday, the Government's version begins to look increasingly like a string of distorted half-truths that belie the realities.

It was undoubtedly true that the Bundesbank was a great deal freer with its views on sterling than it should have been. Mr Schlesinger's ill-advised remarks to the German newspaper Handelsblatt (to the effect that sterling was overvalued in the ERM and needed some adjustment) were the final nail in the pound's ERM coffin. It is perhaps fortunate for him that he is retiring next year for he should never have made them. But it is equally true that the pig-headed determination of the Government to defend an unsustainable exchange rate at almost any cost was the underlying reason for the crisis. If the Government had swallowed its pride at an earlier stage and gone along with the German view, the end might not have been so brutal or humiliating. For British government ministers and high-ranking Treasury officials to phone round the press in the immediate aftermath of Black Wednesday to say, as they did, that the Bundesbank was nowhere to be seen in Britain's hour of need, was not just wrong, it was downright misleading. It was only natural that Mr Schlesinger should want to defend his position and tell the world about the billions spent by the Bundesbank in the futile defence of sterling's parity.

As the slanging match becomes more open and intense, and the pound's slide against the mark continues apace, the issue of blame has in any case ceased to be of great importance. More to the point is the image it has created of a government in crisis, searching for scapegoats and ways of diverting attention from its own failings and now non-existent economic policy. It is hard to recall a more serious political crisis in 13 years of Tory government - perhaps Westland but the issues there were narrowly political and ultimately of little long-term importance. Just five months after winning an election, John Major has successfully achieved what few Conservative prime ministers have before him - the alienation of the entire Tory press. One after the other, they have come out against him, the Telegraph, the Times, the Mail and the Sun.

As far as the markets are concerned, all this adds up to a profoundly depressing picture. The pound's parlous condition in the foreign exchange markets has ruled out the extra cut in interest rates that was expected to accompany this week's Tory party conference. Furthermore, the pound has lost so much value since Britain left the ERM that serious inflation worries are beginning to emerge once more. Add to that the deteriorating political backdrop, the spectacle of a government without any kind of economic policy and the simple truth that there is still no sign of a pick-up in economic activity - if anything things seem to be getting worse - and you end up with a pretty poisonous brew. The stock market looks set for a nasty correction.