Commentary: The franc will get by with a little help

Short of an outright breakdown of the European exchange rate mechanism, the French franc should hold the line for the time being. The London markets are baying for a franc devaluation but they may not see one.

There are powerful reasons for this view and they are not all economic. French economic fundamentals do not justify a franc devaluation: inflation in France is lower than in Germany and French firms are more competitive than their German counterparts. France has a current account surplus and Germany has a deficit. The French budget deficit is a little more than half the size of the German shortfall. And French growth is faster than German.

On top of this, Helmut Kohl and Francois Mitterrand still think European monetary union can be achieved. They will do all they can to persuade the rest of Europe to go along with them. If that aim turns sour, they will try to declare a mini-EMU.

The two leaders, who meet today in Bonn, regard the franc-mark rate as the linchpin of the exchange rate mechanism. If that blows apart then so do their hopes for monetary union. And a franc devaluation could damage the Franco-German alliance that lies at the heart of Europe. It was thus no surprise that in the midst of the September currency crisis they declared the franc-mark rate 'inviolable'. They mean it and are likely to remind the markets of that fact this week.

But the markets sense the ERM is in fundamental trouble because few of its members can sustain interest rates as high as Germany's without damaging their economies. It seems unlikely that all the current ERM members will be able to wait until February or March, when a German rate cut is more likely.

So having picked off Britain and Italy, and humiliated Spain and Portugal, the markets now want French, Irish and Danish blood irrespective of the economic fundamentals.

The Bundesbank, meanwhile, has done little to discourage such speculation. Helmut Schlesinger has laid bare the bank's increasing frustration with the ERM and has questioned the value of unlimited obligatory intervention by a strong-currency country on behalf of a weak-currency country. Here the Bundesbank means not only Italy and Britain, but also France.

It is also fed up with the potential damage to domestic monetary control wrought by large-scale intervention. The bank places far more emphasis on its domestic role and these days barely acknowledges its international obligations.

But Bonn, not the Bundesbank, is responsible for the mark exchange rate. As long as Mr Kohl values the Franco-German alliance, then the Bundesbank will stand by the franc.