Inside Story: Lamont's silver lining: The Chancellor may have lost a burden but he will not throw caution to the winds, writes Donald Macintyre

WALLS you would like to be a fly on: the meeting last Friday of Baroness Thatcher, Norman Lamont, and Sir Robin Leigh-Pemberton, Governor of the Bank of England, at the British Embassy in Washington. It was pure serendipity that all three should be under the same roof after the deepest sterling crisis for 16 years and the biggest political embarrassment of John Major's premiership.

Imagine the scene over pre-dinner drinks. Lady Thatcher is basking, her speech to yesterday's CNN conference already prepared, in the hospitality of Sir Robin Renwick, one of her favourite diplomats when she was at Number 10; the two weary travellers arrive from London, harassed by the impending International Monetary Fund conference, and still faintly in shock after the most nightmarish week in their careers. There is the extra frisson that, as one of those in the Cabinet who told her she could not win the second ballot in November 1990, Lamont carries a share of the blame for her downfall.

It is a safe bet that Lady Thatcher who, by all accounts, does not think Lamont should resign, will have been sweetness itself. In such circumstances she could afford to be. But there was cause for Schadenfreude on the grand scale. In the presence of her fellow house-guests it would have been inhuman not to have purred at her moment of triumph. Had Britain not suspended membership of the exchange rate mechanism which she resisted for 11 long years and only agreed to under threat of the collapse of her Cabinet? Is it conceivable that in Lutyens' splendid embassy in Washington, the dread words 'I told you so' did not at some point this weekend form on her lips?

In fact Lamont may not have dreaded the encounter as much as all that. First, he has dined amiably with Lady Thatcher several times since her downfall. Secondly, the Chancellor, surprisingly for a man who faced a chorus of calls for his resignation last week, left for Washington with - almost - a spring in his step, and with some reason. Then, too, he is still in office.

It is understandable that John Major did not want him to resign. Apart from his loyalty to friends, Major knew first that Lamont's resignation would have underlined a humiliating change of policy. Secondly, Major does not suffer from self-delusion. It is unlikely that he forgot that it was he - and for that matter Lady Thatcher - and not Lamont who took Britain into the ERM on the eve of a recession and when German reunification was set to put the mechanism under strain.

In fact, it would have been disastrous for Lamont if the Government had abandoned its commitment to the ERM altogether; he would have had to resign. But Lamont is a complex man. On Wednesday evening he was every inch the prudent Chancellor. At that time there was certainly some pressure from among the politicians on Lamont to bring interest rates back down to 10 per cent that very evening.

As one Cabinet Minister put it: 'The worst possible think would have been to come out of ERM and have interest rates two points higher than they were at the beginning of the week.'

But Lamont, who was under pressure from a jittery Bank of England, insisted on sleeping on it, and woke up mightily relieved to find that the pound had not gone into free fall and that therefore he could bring rates back to where they were. Yet, as an instinctive Eurosceptic, Lamont may have subconsciously even felt a sort of relief that Britain was - however temporarily - in charge of its own economic policy once again. There was, in the words of one official, a sense of 'Prometheus unbound'.

But the almost light-headed mood among most ministers in the wake of their crisis will be dissipated rapidly. The Government still faces dilemmas on the economy made all the more urgent by the Parliamentary debate called for Thursday. It will be quite an occasion. It will be the first outing for John Smith as Labour leader and for Gordon Brown as Shadow Chancellor. Both are consummate parliamentary performers and they will skirt round the difficult problem that they fundamentally supported British membership of the ERM as strongly as the Government. Their position has been strengthened in that it will be much more difficult for the Tories to taunt Labour with being the party of devaluation. But the Opposition can hardly call for an alternative to the Government's stated policy of returning to the mechanism when conditions allow.

It will, however, use two main arguments. First, the pound was speculated against partly because it was overvalued given the weakness of the British economy. Labour will insist that it always wanted 'ERM plus' - commitment to the mechanism backed by a policy to stimulate industry. Secondly Brown is sure to press ministers to say whether they were offered a general devaluation within the ERM last weekend, and if so why they rejected it. This has the making of a credible onslaught - but there are problems.

The Tories have had some unsolicited help from Bryan Gould's breaking of ranks on economic policy. As the Chevenement of British politics, anti-European from the left and buoyed by the events of last week, Gould - a New Zealander by birth and a Eurosceptic of genuine conviction - has been everywhere on radio and television arguing against the ERM and Maastricht. Recognising that this helps the Tories to inquire what the Shadow Cabinet's policy really is, Brown is understood to have expressed concern to Smith that Gould is seriously undermining the Opposition front bench. A number of loyalist front-benchers have grumbled privately because Smith has yet to carpet Gould. Labour's pro-Europeans fear that the Shadow Heritage Secretary's critique of Maastricht and the ERM could provoke Labour into a superficially tempting scrapping of the policy it has held for two years.

Instead, they argue, Labour should stick to its guns and say that it would have adjusted inside the ERM rather than devalued outside it - a view given some unexpected support yesterday by no less an authority than Lady Thatcher. The glittering prize for doing so, the pro-Europeans argue, is that Labour would not again be condemned for inconsistency. And in the long run, it would maintain a credible anti-inflation policy - something, they will argue, that the Tories can only maintain by resorting, as in the early 1980s, to higher taxes and savage spending cuts.

Nevertheless Labour's serious difficulties will not be enough to get the Government completely off the hook. At present it scarcely has an economic policy. At last Thursday's Cabinet meeting every member present spoke - including David Mellor who, by all accounts, took a hand in drafting the final statement. Consensus was reached, but the views ranged much more widely than suggested by the impressive show of unity that followed the meeting. Some on the pro-European wing, including such figures as David Hunt and John Gummer, were eager to signal a swift return to the ERM. There is the faintest sign that Major, bearing the burden of Britain's presidence of the European community and of the collapse of his policy, was at one point sympathetic to that view.

On the other side Michael Howard, a Eurosceptic, argued strongly against any decision that would commit the Cabinet to rejoining the ERM, at least in the short term. Kenneth Clarke - who with Michael Heseltine and Douglas Hurd had been a 'big hitter' present the previous day - took the line that failure to restate its commitment to the ERM would leave the Government, not to mention the Chancellor, in an impossible position. Equally he was pessimistic that re-entry would be possible in the immediate future. As a pro-European he was sad, but the Cabinet had to be realistic. It was that view, or a version of it, which prevailed at the end of the meeting.

But that leaves a vacuum, which the divergences that began to appear last Thursday will feed on, if it is not quickly filled. In theory there could be a decisive 'yes' vote tonight in France, the exchange markets could stabilise, the summit which Major will call this week could agree new ERM rules to ensure that last week's turmoil does not happen again, and Britain could rejoin the ERM this week. One sober-minded senior member of the Cabinet put the chances of that yesterday at about 50-1 against.

All this puts Major and Lamont under considerable pressure to say on Thursday what economic policy they will substitute for the ERM. It is safe to assume some form of return to monetary targets. A number of Cabinet ministers, including Heseltine and, at least as a matter of theory, Clarke, favour an independent British central bank - a credible alternative to the ERM. Mr Lamont is highly sceptical of the virtues of the concept. And it would be surprising if there was an early decision in favour, first because the Bundesbank, the outstanding example of the species, is currently demon number one for the Tory party; secondly because at least some ministers have been unimpressed by the Bank of England's performance over the past few weeks.

The sharp issue, of course, is interest rates. Some ministers are already worried that the relief which undoubtedly swept through the Tory party last week after last week's suspension of ERM membership may have exaggerated expectations of a big cut in interest rates among most backenchers. The potential dispute is now between those on the right who want drastic reductions in interest rates and even more savage spending cuts; and those who want to maintain some form of loose parity with German rates but find other ways of easing what even Tories now call the 'real economy' - for example by some growth in capital spending.

At present, the expectation among government business managers is that there will now be an interest rate cut before the Tory conference, but that it may be a modest one. The right feels empowered by last week's decision; re-entry into ERM looks a forlorn prospect for the present. On the other hand there is a still a pro-European bias at the top of the Cabinet.

Lamont may instinctively remain a Eurosceptic, but he is unlikely to use his new-found freedom with the abandon that his former friends on the Thatcherite right would like.

(Photograph omitted)