Prospect of G7 intervention sends dollar into reverse

The currency markets went into reverse yesterday, sending the dollar lower and the German mark higher. The triggers were the possibility of official intervention to halt the dollar's two-year rise following next weekend's meeting of Group of Seven (G7) ministers, and the political uncertainty resulting from the prospect of early French elections.

Recent currency swings will be on the agenda at the G7 meeting due in Washington this weekend as both German and Japanese officials have indicated that they think the US currency has climbed far enough.

It has gained about 10 per cent against the mark and almost as much against the yen so far this year, despite an attempt by the G7 in February to talk it lower.

"We are interested in the mark remaining a strong currency," Hans Tietmeyer, Bundesbank President, said at the weekend. Yesterday Eisuke Sakakibara of Japan's Finance Ministry added his weight by warning that it would be dangerous to assume Japan would not raise interest rates to defend the yen.

The dollar was likely to remain weak ahead of the G7 meeting on Saturday, analysts said.

The German currency was also boosted by the news of early French elections. President Chirac's decision was interpreted as an admission that additional austerity measures will be needed if the government budget deficit is to be reduced by enough to meet the Maastricht target.

"It suggests the French government thinks there will be a need for more unpopular measures to cut spending," said Stephen King, an economist at James Capel.

New European Commission economic forecasts, due tomorrow, are expected to show France and Germany scraping under the 3 per cent of GDP ceiling. But the financial markets will take these with a pinch of salt, given the Commission's relentlessly upbeat attitude to the single currency.

Separate forecasts are expected to provide a more realistic assessment. The six leading economics institutes in Germany will today publish a report putting the 1997 budget deficit at just over 3 per cent of GDP.

The half-year economic outlook from the International Monetary Fund on Thursday is reported to be critical of the measures the Italian government has taken to trim its deficit, saying there has been less structural reform than necessary and too many one-off measures.

The result of all these factors has been one of the market's periodic reassessments of the likelihood of European monetary union going ahead on time. Every time the probability seems to recede a little, the mark gets a boost against other European currencies.

"Politics are creeping back in and this has turned around sentiment," said Michael Lewis at Deutsche Morgan Grenfell.

The last effective G7 intervention to turn around currency trends came two years ago. At their meeting in April 1995, ministers agreed to halt the dollar's slide, and it subsequently climbed back from its post-war lows of 79.75 and DM1.3693. It has gained more than 50 per cent against the yen and more than 25 per cent against the mark during the past two years.

"It is not clear that the Japanese should be unhappy about this because it has helped their exporters, but they want to be seen to be saying the right thing. It's a game of trade politics," said Nigel Richardson, an analyst at the Japanese bank Yamaichi.

Although Japan's trade surplus fell in March, the politically sensitive bilateral surplus with the US rose by 11.2 per cent to 379.83bn, the sixth monthly increase in a row.

Even so, the fact that the markets think that the dollar's current exchange rate against the yen is probably about right suggests that a G7 statement will not have a dramatic effect - any more than February's statement that the dollar's earlier misalignment had been corrected.

The dollar dipped from 125.85 to as low as 125.15 and from DM1.7113 to DM1.7020 in London yesterday. The pound fell nearly a pfennig to DM2.7831.