NORMAN LAMONT has begun to behave like a divorcee on the rebound, which is likely to land himself, and us, in trouble. Until Thursday, the Chancellor deserved considerable sympathy. He had never been an enthusiast for the exchange rate mechanism, still less for monetary union. Locked in a loveless ERM marriage, he nevertheless stuck loyally to the match that had been arranged for him by the Prime Minister. With hindsight, that most powerful of all analytical tools, he might have mounted a more credible defence of sterling had he been prepared either to devalue or to raise interest rates modestly earlier. It was the markets' belief that he would never do so which ultimately made the pound a one-way bet.

Since sterling's ejection from the system, the Chancellor has sung a different tune. Take, for example, his remarks at the end of last week: 'We are floating and we will set monetary policy in this country to meet our objectives. It will be a British economic policy and a British monetary policy.' The ERM, which the Chancellor had called the 'cornerstone' of his policy, had become a fallen arch. In Washington for the International Monetary Fund meeting, Mr Lamont was asked when Britain might rejoin the ERM. He cast doubt on ever rejoining by saying that it was not a question of timing, but of when the conditions allowed.

The danger is that the Chancellor himself has now become one of the voices encouraging speculation about a dash for growth. This may sound marvellous to untutored Tory backbenchers labouring under the misapprehension that, with one bound out of the ERM, Norman is free to do what he likes. But to the foreign exchange market, it begins to sound like a recipe for irresponsible and inflationary finance. If the markets think that the Government does not care about the pound, they will sell sterling all the harder. But the Government will eventually start to care a lot, because governments always do. The inflationary impact of rising import prices in a medium-sized economy is too large to ignore. Then we will be looking at interest rate rises, not cuts.

Sterling has already been going south at a considerable rate, and is now nearly 9 per cent below its former floor against the German mark and 14 per cent below the old central rate. This is a sharp relaxation of policy in itself, since it makes exports cheaper in foreign markets, and imports more expensive at home. On the old Treasury rule of thumb, the drop is equivalent to a 2-3 percentage point cut in bank base rates. The fall is also far beyond most estimates of the pound's previous overvaluation, which is unfortunate. Our traders do not need a lower pound, but our debtors do need lower interest rates.

The danger now is that a large interest rate cut could provoke a serious run on sterling that would lead to a rapid reversal. The markets are much less impressed by the prospect of a return to the examination of money measures, asset prices and the exchange rate than they would be by a new, albeit lower, ERM target rate. By setting up a series of targets, Mr Lamont merely makes it easy to hit at least some. The Chancellor and the Prime Minister now need to be very cautious, and to make it clear that the more the pound falls, the less room there is for any further easing on interest rates.