Desperate to Defend Pound, Britain Hikes Interest Rates

AMID chaos in international money markets, Europe's drive toward political and economic unity is in grave jeopardy.

In a symptom of the market's disarray, Britain was forced yesterday to hoist interest rates by 2 percent to 12 percent, and a further 3 percent hike was announced to be effective today, in a desperate effort to defend the pound against devaluation.

The move came after intervention by the Bank of England and other European central banks failed to defend the pound against investors switching to German marks in the run-up to a referendum in France Sunday on the Maastricht Treaty.

Government sources in capitals of the 12-nation European Community said a French "no" vote would have a severe adverse effect on European unity. Britain has yet to place the Maastricht Treaty before Parliament for ratification.

Immediately after the interest-rate rise, the British Treasury said the move was "out of line with economic fundamentals."

Most British industrialists believe a cut in interest rates is necessary for the country's economic recovery.

A British Cabinet minister, who asked not to be named, said: "If the French vote yes, we may just weather the current crisis. If not, the entire unification process is likely to unwind."

EC governments were further jolted yesterday by reports that President Francois Mitterrand is seriously ill. Doctors said the French leader would be resuming his duties before Sunday and would vote in the referendum. Along with Chancellor Helmut Kohl of Germany, Mr. Mitterrand is a true believer in European unity and has campaigned vigorously to persuade the French electorate to endorse the Maastricht Treaty.

The watershed significance of Sunday's vote was stressed by Valery Giscard d'Estaing, the former French president, who said Tuesday: "A `no' vote would turn back the clocks and mean that we will not see a single European currency in our lifetimes."

Opinion polls are banned in France in the week before voting. But official sources in Paris said the outcome was likely to be a slim "yes" vote. The sources admitted that Mitterrand's current popularity rating of only 29 percent was likely to be a negative factor. They appeared uncertain whether the president's illness would influence how the French vote on Sunday. `A deep and growing crisis'

Prime Minister John Major's rearguard battle to protect the British currency appeared to have been undermined by a pile-up of other damaging developments.

A senior British official spoke of a "deep and growing crisis of confidence" within the EC and warned that chaos in money markets was "imperiling the Maastricht goal of European union." The official complained that Helmut Schlessinger, president of Germany's Bundesbank, had made a bad situation for the pound worse by reportedly telling the Wall Street Journal Tuesday that a more comprehensive realignment of European currencies might be necessary.

Mr. Schlessinger was responding to criticism in London and other EC capitals that the Bundesbank's quarter percent drop in its base lending rate, announced on Monday, had been a feeble response to the crisis and had created an atmosphere of anticlimax and uncertainty.

A day earlier, Italy in effect devalued the lira by 7 percent amid hopes by European currency and stock dealers that the Bundesbank intended to cut its base rate by a full 1 percent. Ian Amstad, a senior economist with Bankers Trust in London, said: "It's gone from a fairly optimistic picture to a nightmare in two days."

On Tuesday Mr. Major took the unusual step of canceling an official visit to Spain scheduled for the next day. Downing Street officials said the cancellation was "unrelated" to the financial crisis. But John Smith, leader of the opposition Labour Party, said: "This move represents a complete failure of the Conservatives' economic policy." He said it would have serious consequences for industry and for jobs and urged the recall of Parliament from its summer recess to consider the crisis. Pound at rock bottom

As the London money market opened yesterday the pound stood at rock bottom within the European Exchange Rate Mechanism (ERM). After interest rates were raised, David Cocker, a dealer with Chemical Bank in London, said insufficient funds had been available to bolster the pound. "The Bank of England had around British pounds30 billion to mobilize in a foreign-exchange market that trades about British pounds187 billion each day," he said. When help from other European central banks also failed to aid sterli ng, an interest-rate rise became inescapable, he added.

The ERM of the European monetary system fixes each country's exchange rate against those of the others. When Britain joined the ERM in October 1990, it had to hold sterling within 3 percent of a central rate of 2.95 German marks to the pound. If a country's currency falls below its lower ERM band it can either raise interest rates or negotiate a revaluation within the system. Major chose to boost interest rates.

After that action, Norman Lamont, chancellor of the exchequer, said the government's policy was determined by "whatever is required to maintain sterling's position within the ERM."