View from City Road: Scheming to send the right signals

ACTIONS speak louder than words. The Treasury's announcement yesterday that it intends to borrow pounds 7.25bn in foreign currency to support the pound and help to fund the public sector borrowing requirement has done more to convince the financial markets that the Government does not intend to devalue sterling than would a dozen bravura performances by Norman Lamont on the steps of the Treasury.

The foreign currency borrowing scheme was launched at a propitious moment with investors increasingly worried about the implications of a French 'no' vote for the Maastricht treaty on 20 September. The reassuring effect reinforced the beneficial effects of better-than-expected results on the first day of the autumn reporting season. These augur well for the next few weeks though they should be seen in the context of massive downgradings over the summer.

The scheme has sent three useful signals to the markets. First, it adds credibility to the Government's claim that it does not want to see sterling devalued against the mark if the French referendum rejects the Maastricht treaty. The Government will have a debt of at least DM5bn (pounds 1.84bn) hanging over its head on 20 September. A 10 per cent mark revaluation would increase the cost of repaying it by almost pounds 200m. The rest of the borrowing, to start later in the month, will exert a similar discipline.

Second, the foreign exchange that the Government intends to borrow will be sold in the currency markets for sterling. This will help to support the pound in a similar fashion to the intervention carried out by the Bank last week, although the element of surprise will of course be lost.

Third, by using the proceeds to help to fund the PSBR, the Government reduces the amount it has to borrow from the gilts market, which has been depressed by the prospect of a PSBR of more than pounds 30bn in 1992/3. The Government has funded about pounds 15bn from the gilts market so far, and so at a stroke has probably almost halved the amount it will need to raise in the market in the rest of the year. Hardly surprising the gilts market reacted so favourably.

By boosting the pound the scheme has already helped to lift the threat of an interest- rate rise to defend the currency. That in itself is good news for equities. But it is by no means certain that the effect will be enough to resist the pressures that could still arise from a 'no' vote. What the scheme has done is to make a rate rise less likely rather than to remove the possibility altogether.