Europe Currency Markets in Chaos : Finance: Britain and Italy suspend links to EC monetary rates structure. Meeting of finance ministers from 11 nations apparently fails to resolve the crisis.

Chaos engulfed Europe’s currency markets today, swamping the struggles of Britain and Italy to protect their currencies’ value and forcing a devaluation of the Spanish peseta.

Finance officials of 11 nations, in an emergency session that began shortly before midnight and lasted until 5 a.m. today, apparently failed to resolve the runaway crisis. Their communique was silent on high German interest rates, which are widely held responsible for Europe’s currency crisis.

Emerging from the meeting, Horst Koehler, the second-ranking official in Germany’s finance ministry, refused to discuss Germany’s policy. Asked when currency markets would again be calm, he replied, “Today.”

The communique urged Britain and Italy, who temporarily withdrew from the European Monetary System’s exchange rate mechanism, to recouple their currencies’ values to those of the other nine nations “as soon as possible.”

Wednesday’s turmoil was focused on London, where the British government twice raised interest rates by massive amounts, first from 10% to 12% and then to 15%. But the pound continued losing value, leading the government to give up its desperate efforts in the evening.

The pound promptly plunged by more than 4% on international currency markets. Without the British government’s guarantee to support it, it was expected to continue its descent today.

Such continuing turmoil brings with it the distinct possibility that the already faltering U.S. economic recovery could be blunted.

It also casts a shadow over prospects for Europe’s plans for further monetary and political unification. French voters will pass judgment Sunday on the EC’s blueprint for such greater unity, known as the Maastricht Treaty.

Already the turmoil has extended beyond the European Community: Sweden’s central bank lifted its overnight lending rate to commercial banks to a stratospheric 500% in a desperate effort to protect its currency.

Sweden’s lending rate was raised from 16% to 75% last week but trimmed to 20% Monday after Germany cut interest rates.

Britain and other EC countries also put intense pressure on Germany to bring down its high interest rates, which, by attracting investment funds from all over the world, have boosted the German mark’s value against that of other European currencies.

For most of Wednesday, the British government stuck to its policy of supporting the pound at all costs.

“I have made it clear the government is prepared to take whatever measures are necessary” to support the pound’s value, Chancellor of the Exchequer Norman Lamont declared early in the day.

Hours later he had to eat those words. To the government’s consternation, the pound maintained its stubborn descent in the teeth of the two massive interest rate increases and frantic buying by the Bank of England. So at 7:20 p.m., Lamont announced that he was throwing in the towel.

“The government has concluded that Britain’s best interests would be served,” he said, by temporarily severing the links that tied the value of the pound to that of other EC currencies. Those links had obliged the government to intervene when markets threatened to push the pound below its acceptable limits.

Germany reduced its rates Monday as part of a deal in which Italy, whose lira is even weaker than the pound, devalued its currency by 7%.

But the reduction in key German interest rates was only 0.25 to 0.5 percentage points, far too little to close the roughly 6 percentage-point gap with U.S. rates.

The dollar was the surprise winner out of Europe’s chaos Wednesday, as global investors bought the U.S. currency as a haven. The dollar closed in New York at 1.514 German marks, up from 1.491 marks on Tuesday.

The German rate cut was also too little to relieve the pressure on the lira and the pound. By Wednesday, investors had driven the price of the lira close to its new minimum value against the mark, and Italy, without making a formal announcement, abandoned its effort to prop up the currency. A further devaluation seemed likely.

The Spanish peseta was devalued by 5% by agreement of the finance officials meeting in Brussels. They said Spain requested the devaluation.

The central banks of two other EC nations with strong currencies, the Netherlands and Belgium, reduced interest rates earlier Wednesday to try to relax the pressure on the weaker currencies.

The chaos might not be confined to one side of the Atlantic. Analysts said Europe’s currency crisis could damage the U.S. economy in two ways: by weakening European demand for American goods and adding new doubts to the already uncertain U.S. investment climate.

“The United States has its own economic problems and desperately needs overseas markets,” said Alan Stoga, an economist with Kissinger & Associates in New York. Europe is a major market for U.S. goods, he said, and economic setbacks there cut into U.S. exports.

“The world’s economies are interconnected, and chaos there risks spilling over here,” Stoga added. “That means investors don’t invest, or they charge more when they put their money at risk, and that means higher interest rates.”

The pound collapsed despite the desperate efforts of the British government to fulfill its obligations under the European Monetary System to support it.

First the Bank of England bought billions of pounds on international currency markets in an attempt to offset the effects of speculators who were selling the currency in the belief that its value would fall.

When that failed, the government announced the first increase of 2 percentage points in Britain’s basic short-term interest rate, from 10% to 12%.

That too failed to brake the pound’s slide, even though higher interest rates usually increase a currency’s value by attracting investments. So the government announced that a further 3-point rate increase, to 15%, would take effect today.

When that did not stem the rout, Lamont gave up. He canceled the day’s second increase in interest rates and said the basic rate would be 12% at the opening of business today.

Times researcher Isabelle Maelcamp contributed to this story. Times staff writer William Tuohy in London also contributed to this story.

Currency Troubles (Southland Edition, A10)

At stake: The system that links the values of 11 European currencies and obliges governments to intervene in markets when values get out of line.

System’s advantages: Stable exchange rates provide investors with the certainty they need before they risk their money.

Its disadvantages: Divergent economic conditions in different EC countries can make the maintenance of stable exchange rates all but impossible.

Strong currency: German mark, which is benefiting from Germany’s high interest rates.

Weak currencies: Italian lira, which was devalued by 7% last Sunday, and British pound, which lost almost 4% of its value after being cut loose from other European currencies Wednesday.

Source: Times staff