British Pound Posts Biggest Weekly Drop Since Black Wednesday

By Kim-Mai Cutler

Oct. 25 (Bloomberg) -- The pound fell below $1.53, posting its biggest weekly drop since Black Wednesday in 1992, after a report showed the U.K. economy contracted more than forecast in the third quarter, bringing the nation to the brink of a recession.

The pound's 5.9 percent intraday slide yesterday was the most in at least 37 years and the weekly decline was the biggest since September 1992, when Britain was driven out of Europe's Exchange Rate Mechanism. Gross domestic product shrank in the third quarter by more than twice as much as analysts predicted, a report showed yesterday, putting the economy on course for its first recession since 1991. The FTSE 100 Index slumped and the yield on the two- year gilt had its steepest weekly drop in more than 15 years.

``This is once-in-a-lifetime stuff, we're all sat under our desks with tin hats on,'' said Neil Mellor, a currency strategist in London at Bank of New York Mellon Corp. ``The U.K. is in the first step toward a recession and the dollar's bid because of repatriation flows.''

The U.K. currency fell 8.2 percent in the week to $1.5269, the lowest level since August 2002, and traded yesterday at $1.5866 as of 6:40 p.m. in London. Against the euro, the pound was at 79.60 pence, declining 2.5 percent in the five days, the most since December 2004.

A collapse in credit markets and the worst housing slump in a generation have buffeted the British economy, Europe's second- biggest. The U.K. is already in a recession and the economy will contract for the next three quarters, Ernst & Young's ITEM Club, which uses the same forecasting model as the Treasury, said in a report on Oct. 20.

`Black Wednesday'

The economy shrank 0.5 percent in the third quarter, the Office for National Statistics in London said yesterday. The median forecast of 35 economists in a Bloomberg survey was for a contraction of 0.2 percent.

The weekly drop in the pound was the most since the week of Black Wednesday on Sept. 16, 1992, when U.K. Prime Minister John Major pulled the currency out of the Exchange Rate Mechanism. The currency lost 9.8 percent that week.

Yesterday's intraday decline was the largest since at least 1971, when former U.S. President Richard Nixon suspended the dollar's convertibility into gold and ended the global fixed exchange-rate regime set up at the Bretton Woods conference at the end of World War II.

``These moves are absolutely without precedent,'' said David Watt, a Toronto-based currency strategist at Royal Bank of Canada Ltd. ``The 1970s are pretty much the extent of the data you're going to get because currencies didn't even float that far back.''

$1.40s `Soon'

Volatility on one-month pound-yen options, a measure of expectations for future price swings, rose to 47.24 percent, the highest on record, indicating greater risk market moves may erode profits. The pound lost 15 percent against the yen in the week.

The pound may fall to the $1.40s ``very soon,'' said Hans- Guenter Redeker, London-based global head of currency strategy at BNP Paribas SA, the most accurate forecaster in a 2007 Bloomberg News survey.

``It has a lot to do with the underlying conditions in the British economy and how the situation in Europe as a whole is currently developing,'' Redeker said yesterday in an interview on Bloomberg television.

House prices will continue to fall and the pound may depreciate further, Bank of England Governor Mervyn King said in a speech to executives in Leeds, England, on Oct. 21.

Prime Minister Gordon Brown predicted the next day that the U.K. will slip into a recession for the first time since he took charge of Britain's finances in 1997. The remarks were Brown's first admission that the country's longest unbroken streak of economic growth in more than a century is over.

Rate-Cut Bets

``The combination of a squeeze on real take-home pay and a decline in the availability of credit poses the risk of a sharp and prolonged slowdown in domestic demand,'' King said. The Monetary Policy Committee ``will act promptly to ensure that inflation remains on track to meet our target.''

For the U.K. economy, the pound's drop will benefit manufacturers including Nissan Motor Co. and Ford Motor Co., which have factories in Britain, and help bring about the ``rebalancing'' that King has said for years is needed.

Earlier this week, King signaled he expected sterling to weaken further, noting that investors may be losing their appetite for U.K. assets because of the approaching recession, drying the amount of funds flowing into London banks.

``Unless they are replaced by other forms of external finance, the adjustments in the trade deficit and exchange rate will need to be larger and faster than would otherwise have occurred, implying a larger rise in domestic saving and weaker domestic spending in the short run,'' King said.

Bonds Jump

The chances that the Bank of England will lower its benchmark interest rate by as much as three-quarters of a percentage point by year-end rose to 30 percent yesterday, a Credit Suisse Group AG index of derivatives showed. The odds of a cut of that magnitude were 5 percent a day earlier.

Government bonds rose, with the yield on the two-year gilt plunging 54 basis points in the week to 3.09 percent, the steepest drop since February 1993. The 4.75 percent note maturing June 2010 climbed 0.84, or 8.4 pounds per 1,000-pound ($1,583) face amount, to 102.59. The yield on the 10-year security dropped 31 basis points to 4.36 percent, on course for its biggest weekly decline since 1999. Bond yields move inversely to prices.

To contact the reporter on this story: Kim-Mai Cutler in London at kcutler@bloomberg.net