Reserves show steep fall after help for pound

THE BANK of England's efforts to prop up the pound helped to reduce Britain's reserves of gold and foreign currency by an unexpectedly large dollars 1.3bn ( pounds 650m) last month, Treasury figures showed yesterday.

Last week's support buying of sterling was the largest since the aftermath of Nigel Lawson's resignation as Chancellor of the Exchequer in October 1989. But the currency markets were relatively quiet yesterday, with the pound strengthening slightly against the dollar and the mark.

Almost 3 per cent of the reserves were used up in August, leaving dollars 44.5bn ( pounds 22.3bn) at the end of the month.

For accounting purposes the month ended last Wednesday, the day on which the Bank of England spent almost dollars 1bn ( pounds 500m) in its most overt intervention in support of the pound since the IMF crisis of 1976-7.

The figures do not include the effects of intervention on Thursday and Friday last week, when the Bank made limited purchases of sterling to remind the market that it was ready to take more dramatic steps if needed.

The Bank's participation in concerted central bank intervention to support the dollar by selling marks also does not show up in the figures. On 22 August alone, 17 central banks spent dollars 1.5bn defending the dollar.

Excluding payments on maturing ecu Treasury bills and proceeds from new bills, the underlying change in the reserves in August was dollars 1.28bn. The change includes interest receipts on the stock of reserves and interest payments on foreign currency borrowing. Foreign currency payments by government departments, such as soldiers' pay in Germany, also reduce the reserves.

There was no sign of intervention yesterday. The pound gained just over a quarter of a pfennig to close at DM2.7862, still less than a pfennig above its floor in the exchange rate mechanism.

The dollar fell slightly against sterling and the mark. It dropped by a tenth of a pfennig to DM1.3905, a record low. The pound rose by 0.3 cents to dollars 2.003, a new high since 1981. The dollar took little comfort from a 1.1 per cent fall in US factory orders in July to dollars 241.76bn, although the drop was slightly smaller than forecast.

Dealers said dollars 2 was acting as a psychological floor to the pound for corporate currency transactions, having operated as a ceiling when the pound was below that point. This helped to buoy the pound against the mark.

Fears of an interest-rate rise to defend sterling eased further in the money markets. The three- month interbank lending rate - which tracks City base rate expectations - fell by 1/8 of a percentage point to 107 16 . This still suggests the market expects the next move in rates to be up rather than down and fully discounts a quarter-point rise.

Today's Bundesbank council meeting is not expected to change German official interest rates - the Lombard and Discount rates within which money market rates can fluctuate. Nor did money market interest rates ease yesterday, as some observers had hoped. Western German industrial production fell 0.3 per cent in July, with figures expected to be released today showing that German gross domestic product fell 1 per cent in the second quarter.