Commentary: Sterling's nasty whiff of failure

There was a nasty whiff of failure around the pound yesterday. With sterling at its permitted floor, the markets are beginning to scent a devaluation. For much of this week, the markets have seemed to be most impressed by the cut in German interest rates as a signal that the Bundesbank would help to save the European Monetary System. But yesterday it began to dawn on more traders that the first devaluation for five years may merely have opened the floodgates.

We do not know how much the Bank of England supported sterling yesterday. The markets were awash with wild rumours. The Bank may have been merely softening the pound's fall all the better to squeeze any bears later. It takes more courage to sell sterling you do not have (in the hope of buying it more cheaply later) when the pound is at its floor than when it still has 6 per cent or more to fall. It is a bet on devaluation.

The game is not over yet: the reserves still stand at some dollars 44bn. There is another pounds 7bn of borrowing of foreign currencies, and the system's unlimited credit facilities. The Government can also raise interest rates. But for all that, governments can ultimately be blown off course. The colossal scale of the Italian intervention - perhaps pounds 15bn in two weeks - is a reminder of the markets' elemental forces. With dollars 187bn a day traded in London, the Chancellor's war chest could go in weeks. Having humbled the Italians, the danger has always been that the markets would then turn to the next-weakest link in the chain.