Pound Posts Biggest Monthly Drop Since 1992 as Recession Looms

By Agnes Lovasz and Lukanyo Mnyanda

Nov. 1 (Bloomberg) -- The pound fell against the dollar, logging the biggest monthly decline in 16 years last month, after U.K. consumer confidence slumped in October, adding to signs Europe's second-largest economy is sliding into a recession.

The U.K. currency snapped a three-day gain against the dollar and the difference between two- and 10-year government bond yields widened to the most in 12 years after a GfK NOP index of sentiment slid to near the weakest level since at least 1974. Policy makers will probably lower the benchmark interest rate by a half point to 4 percent next week, according to a Bloomberg survey.

``The U.K. is in the epicenter of the crisis,'' said Lee Hardman, a currency strategist in London at Bank of Tokyo- Mitsubishi Ltd. ``The Bank of England's now in a position to aggressively ease monetary policy going forward. The removal of the interest-rate support will further undermine the pound from already depressed levels.''

The pound fell to $1.6198 by late yesterday in London, from $1.6451 the day before and $1.5897 a week earlier. The U.K. currency dropped about 9.2 percent in October, the steepest monthly decline since 1992. Against the euro, the pound was at 78.78 pence, from 79.30 pence on Oct. 24. It rose against the common currency for a second month.

The pound will fall to $1.40 in the next six months and to between 81 pence and 82 pence versus the euro, Hardman forecast.

Shrinking Economy

Britain's economy is shrinking amid the fallout from the global credit crisis. A government report Oct. 24 showed a greater-than-forecast 0.5 percent contraction in the third quarter. A gauge of consumer willingness to make major purchases dropped to minus 42 last month, the lowest level since the series began, GfK NOP said yesterday. House prices fell in October by the most since at least 1991, Nationwide Building Society reported two days ago.

U.K. policy makers lowered the main interest rate by a half point on Oct. 8 in concert with other major central banks to stave off a collapse of the financial system. The implied yield on the short-sterling futures contract due in December declined 20 basis points yesterday to 4.19 percent, signaling a further cut is expected. It was at 4.64 percent a week earlier.

The Bank of England, together with the European Central Bank, must loosen monetary policy more to give the economy a further boost, the Wall Street Journal reported in its ``Heard on the Street'' column yesterday.

Yield Spread

Two-year gilts rose yesterday, with the yield down 3 basis point to 2.92 percent. The 4.75 percent security maturing in June 2010 gained 0.03, or 30 pence per 1,000-pound ($1,615) face amount, to 102.83. The 10-year yield rose 9 basis points to 4.53 percent. Bond yields move inversely to prices.

The difference in yield, or spread, between two- and 10-year government notes widened 12 basis points to 161 basis points, the most since September 1996, as investors favored shorter-dated securities on expectations of rate cuts as early as next week.

Prime Minister Gordon Brown's spending plans are likely to hurt demand for gilts in coming years and saddle future generations with higher taxes, according to George Osborne, a Conservative Party politician who shadows Chancellor of the Exchequer Alistair Darling in Parliament.

``Everyone assumes the only question is how much more does the British government want to borrow from the markets,'' Osborne said in a speech in London yesterday. ``Talk to former chancellors and they will tell you that at some point the question becomes how much more are the markets prepared to lend.''

To contact the reporters on this story: Agnes Lovasz in London at alovasz@bloomberg.net; Lukanyo Mnyanda in London at lmnyanda@bloomberg.net