Pound Sinks to Record Against Euro on Zero Interest-Rate Bet

By Gavin Finch

Dec. 18 (Bloomberg) -- The pound edged closer to parity with the euro, sinking to a record for the ninth straight day on speculation the Bank of England will follow the Federal Reserve in cutting the cost of borrowing to zero.

The British currency fell to 95.5 pence per euro for the first time as a government report showed the U.K.’s budget deficit widened to a record in November as tax revenue declined because of the worsening recession. A separate report showed mortgage lending fell 51 percent in November from a year earlier.

“U.K. rates are going close to zero and the pound is going to suffer until we get there,” said Neil Jones, head of European hedge fund sales at Mizuho Capital Markets in London. “Parity with the euro is the next big psychological barrier.”

The pound slipped as much as 3 percent to 95.57 pence per euro, the lowest level since the common currency’s debut in 1999. It was at 95.09 pence at 1:19 p.m. in London. Against the dollar, it dropped to $1.5391 from $1.5536 yesterday.

With the economy in recession for the first time in 17 years and institutions reticent to lend because of the global financial crisis, the Bank of England has cut its benchmark interest rate to the lowest in more than five decades.

The central bank reduced the base rate to 2 percent on Dec. 4, down from 5.5 percent at the start of the year. The European Central Bank pared its benchmark to 2.5 percent on the same day. ECB President Jean-Claude Trichet said there is a limit to how far the bank can cut rates and signaled it may pause in January, according to comments published two days ago.

Fed Goes to Zero

The Fed cut interest rates on Dec. 16 to a range of zero to 0.25 percent and said it “will employ all available tools” and keep borrowing costs low for “some time.”

The pound has fallen 22 percent against the euro and the dollar this year. Against a trade-weighted index, it has fallen 23 percent in the year to 72.54, the lowest level on record, according to indexes compiled by Deutsche Bank AG, the world’s biggest currency trader.

“We’re seeing the sterling downtrend accelerate,” said Ian Stannard, a foreign-exchange strategist at BNP Paribas SA in London. “There is potential for further sterling weakness toward the parity level.”

The pound has plummeted this week as separate reports showed jobless claims rose last month at the fastest pace since 1991, house prices extended declines and inflation slowed.

‘Be Aggressive’

Interest-rate futures showed traders raised bets U.K. policy makers will reduce borrowing costs, with the implied yield on the March short-sterling three-month contract dropping 12 basis points today to 1.71 percent. It was at 2.20 percent a week ago.

“The monetary authorities have got to be aggressive,” former policy maker Charles Goodhart, now a professor at the London School of Economics and Political Science, said in a Bloomberg Radio interview broadcast yesterday.

Goodhart said Bank of England Governor Mervyn King should approach next year with “courage, flexibility and perhaps going a bit too far with the very serious occasion we’re in.”

The U.K. economy shrank 0.5 percent in the third quarter, and the central bank last month predicted it would contract through most of next year. Policy makers said that surveys signaled further drops in gross domestic product in the fourth quarter and the first three months of 2009.

Britain had a 16 billion-pound ($24.6 billion) budget deficit last month, the largest since records began in 1993, the Office for National Statistics said in London today.

The pound tumbled yesterday after the government said the number of Britons receiving unemployment benefits rose 75,700 to 1.07 million people, the highest level since July 2000.

To contact the reporter on this story: Gavin Finch in London at gfinch@bloomberg.net