Commentary: British rate rise is not automatic

There is now a phoney war in the markets. Positions have been built up in anticipation of the Bundesbank meeting tomorrow, but there is no inclination among dealers to chance their arms any further. Bets have been laid and we are waiting to see the outcome, which is why the pound marked time yesterday. The possibilities tomorrow are obvious. Nothing will happen to German rates and the mark will fall, leaving some speculators with a bloody nose but the pound recovering, in a very weak fashion, from its position well below all the other currencies in the exchange rate mechanism.

There could be some technical fiddling by the Germans, designed to raise money market rates a fraction, which is probably what the foreign exchange market is now discounting. Such a move could conceivably bring sterling off the bottom, as there is still a suspicion that it has been too heavily sold.

Finally, there could be a full half-point rise in German interest rates, leaving the Government to decide whether to test the hypothesis of Mervyn King, the Bank of England economist, that UK rates can sometimes fall below German rates.

This test should be easier to carry out if Germany raises rates than if Britain takes the initiative - now a somewhat theoretical proposition - to move down. But the Prime Minister's anti-devaluation stance is not a repeat of Labour's embarrassing antics in 1967, except perhaps to a few MPs with long memories. We have to assume he really means it. The King hypothesis needs sterling much higher in the ERM to work.

A British rate rise would not be entirely automatic. It is conceivable that the market would take fright at the problems that caused a German rates increase, and react to those instead, by selling the mark. In the short term, such inconsistencies are the stuff of foreign exchange dealing. But don't bet on them this time.