Pound Falls to 5-Year Low Against Dollar as King Sees Recession

By Kim-Mai Cutler

Oct. 22 (Bloomberg) -- The pound slid to the lowest level in more than five years against the dollar after Bank of England Governor Mervyn King said Britain's worst banking crisis since World War I is likely to push the economy into a recession.

The British currency fell as much as 5 cents against the dollar and also declined versus the euro as the National Institute of Economic and Social Research said the economy will undergo its first full-year contraction since 1991. Policy makers voted unanimously to lower the key interest rate a half- percentage point to 4.5 percent in coordinated cuts with other central banks around the world on Oct. 8, minutes of their meeting showed today.

``These are exceptional moves, moves that come along once in a decade,'' said Simon Derrick, chief currency strategist in London at Bank of New York Mellon Corp. ``King certainly acted as a catalyst, but in fairness risk aversion had been kicking around long before that.''

The U.K. currency fell as much as 3 percent to $1.6203, the lowest level since September 2003, and traded at $1.6437 as of 2:34 p.m. in London, from $1.6706 yesterday. It was the steepest intraday decline in 16 years and brought this week's drop to 5.6 percent. Against the euro, the pound weakened to 78.43 pence, dropping for a third day, from 78.17 pence.

The pound may slide 4.2 percent against the dollar, said Kevin Edgeley, a technical analyst in New York at Goldman Sachs Group Inc., citing charts used to predict price movements.

``After a correction higher, prices have weakened again, turning the short-term momentum bearish,'' Edgeley wrote in a research note yesterday. The pound closed below $1.7045 yesterday, opening up ``a target around $1.60,'' he wrote, citing weekly and monthly stochastic and trend-strength indicators.

Pound `Overvalued'

British house prices will continue to fall and the pound may depreciate further, King said yesterday in a speech to executives in Leeds, England, acknowledging for the first time that a U.K. recession is likely.

``Quite clearly the market had seen the pound as overvalued,'' Ross Burland, head of corporate dealings at RationalFX in London, said in a Bloomberg Television interview. ``All it took was Mervyn King to come out and just say really what was already in place, we are entering a recession.''

U.K. stocks declined for a second day and bonds advanced as signs the deepening slowdown is eroding company earnings prompted investors to shun riskier assets in favor of fixed income. Home Retail Group Plc, the owner of Britain's Argos stores, reported a first-half loss today and said annual profit may be at the lower end of analysts' estimates.

Yield Spread

The yield on the U.K. two-year gilt fell 23 basis points to 3.22 percent. The 4.75 percent note maturing June 2010 advanced 0.36, or 3.6 pounds per 1,000-pound ($1,643) face amount, to 102.43. The yield on the 10-year security dropped 10 basis points to 4.51 percent. Bond yields move inversely to prices.

The spread, or difference in yields, between two- and 10- year notes increased to 131 basis points, or the widest since October 1996, in a sign traders expect the Bank of England to lower interest rates again by year-end.

The U.K. Treasury will auction 3 billion pounds of 5 percent notes due in 2018 tomorrow to help finance the government's rescue of the three of the country's major banks. The cost of borrowing among banks fell in Europe today after the U.S. Federal Reserve made as much as $540 billion available to money-market funds to resuscitate lending.

``The age of innocence, when banks lent to each other unsecured for three months or longer at only a small premium to expected policy rates, will not quickly, if ever, return,'' King said. ``I hope it is now understood that the provision of central bank liquidity, while essential to buy time, is not, and never could be, the solution to the banking crisis, nor to the problems of individual banks.''

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