Direct intervention in currency markets to defend the dollar declined significantly during the May-July quarter, and the U.S. was able to repay $1.7 billion in swap-line debt to the Western German central bank during this period, the Federal Reserve Bank of New York reported yesterday.

The regular quarterly report on Treasury and Fed foreign exchange operations does not cover the latest bout of severe dollar weakness, which occurred in August, however, and Fed officials declined to comment on how extensive intervention was during this period.

The officials who briefed reporters claimed "the dollar is ridiculously low" now in relation to other currencies based on relative economic performance. But they said the exchange markets remain extremely pessimistic about the ability of the U.S. either to control inflation or reduce the trade deficit, and this skepticism is continuing to dog the dollar.

Scott Pardee, the Fed's deputy manager for foreign operations, said the U.S. currency is caught "in the throes of a vicious cycle," as the cost of imports rises due to the effect of dollar's depreciation, adding to domestic inflation, and thus weakening the dollar even more.

Allan Homes, the New York Fed's executive vice president for foreign operations, said current imbalances between the economic performance of countries do not justify the exchange rate differentials quoted in the markets. But he added that the markets are protecting high U.S. inflation rates into the next decade. Holmes said "controlling inflation is crucial" to strenghtening the dollar.

In the May-July quarter, U.S. direct intervention totaled $332.3 million compared with $1.25 billion in the February-April quarter. This consisted of sales of $300.3 million equivalent of German marks and $32 million of Swiss francs to help bolster the dollar.

There again was no intervention with Japanese yen. Holmes explained that the U.S. remained unsatisfied with Japan's inability to make any dent in its huge trade surplus.

The FED and Treasury meanwhile took advantage of a period of decline for the mark from March to mid-May to buy marks and pay back $1.7 billion owned to the West German Bundesbank under a special currency swap line with the West German monetary authority. At the end of July. swap indebtedness to the Bundesbank totaled $748 million. The Treasury never has announced total credit available under this swap arrangement.