Pound slumps ahead of an expected interest rate cut

The British pound traded near its lowest level in 22 months against the dollar after the Bank of England cut its economic-growth forecast yesterday, signalling it may reduce interest rates.

Bank of England Governor Mervyn King said yesterday he saw a "chill in the economic air" after unemployment climbed in July by the most in almost 16 years. The pound has lost 5.4 per cent against the dollar in the past 10 days, more than any other major currency except the South African rand and Australian dollar.

"The central bank has effectively opened the door for an interest-rate cut, possibly as soon as next month," Lee Ferridge, a foreign-exchange strategist in London at State Street Global Markets, a unit of the world's largest money manager for institutions, wrote in an e-mailed note to clients yesterday. "Sterling has obviously reacted significantly to this."

The British currency was at $1.8750 by 12.18pm in London, from $1.8704 yesterday. It fell earlier to $1.8619, its lowest level since October 2006. The pound rose to 79.57 pence per euro, from 79.76 pence.

The depreciating currency highlights concern a slumping housing market is pushing Europe's second-biggest economy towards a recession. A drop in house prices in July brought the property market to a "virtual standstill", the Royal Institution of Chartered Surveyors said three days ago.

The economy will grow about 0.1 per cent on a year-on-year basis in the first quarter of 2009, compared with a previous prediction of one per cent, according to bank forecasts published on Wednesday.

The pound is down 5.8 per cent versus the dollar this year, after being little changed against the US currency as recently as July 31. It fell 7.8 per cent against the euro.

Options traders are the most bearish in seven months on the pound versus the dollar, risk reversal rates showed. The premium traders are paying for six-month pound put options, which provide the right to sell the currency, relative to calls rose to 1.2 percentage points, the highest since January, according to data compiled by Bloomberg. Calls grant the right to buy a currency.

Technical indicators said the pound is due for a recovery. The 14-day relative strength index was at 20.24 yesterday. A number below 30 signals a change in price direction.

"From a technical perspective, it is extremely oversold," wrote Lee Hardman, a currency strategist in London for the Bank of Tokyo-Mitsubishi. "However, any bounce for the pound is likely to be limited." The pound is likely to breach the $1.80 level and 190.00 against the Japanese yen over the next six to 12 months, Hardman forecast.

Meanwhile, the euro came under pressure yesterday, as figures showing contraction in the euro zone's economy backed an increasingly gloomy view of global growth, giving a further boost to the US dollar.

German and French growth shrank in the second quarter, culminating in a 0.2 per cent contraction in overall euro area growth that raised the spectre of recession in Europe.

The deterioration in global growth has stoked expectations for monetary easing from central banks around the world sooner or later, reducing the yield advantage many currencies such as the euro and sterling currently enjoy over the dollar.