U.K. Pound Trades Near Record Low Versus Euro as BOE Cuts Rate

By Matthew Brown and Gavin Finch

Dec. 4 (Bloomberg) -- The pound traded close to an all-time low against the euro and near the weakest since 2002 versus the dollar as the Bank of England cut its key interest rate to the lowest level since 1951.

The nine-member Monetary Policy Committee, led by Governor Mervyn King, lowered the benchmark bank rate 1 percentage point to 2 percent, matching the median forecast of 61 economists in a Bloomberg News survey. Britain’s economy shrank 0.5 percent in the third quarter as a collapse in bank lending dried up credit to businesses and consumers.

“Overall the 100 basis-point cut is going to be seen as disappointing,” said Ian Stannard, a foreign-exchange strategist at BNP Paribas in London. “Although 100 basis points was fully priced in, expectations were rising during the day for an even bigger rate cut.”

The pound fell to $1.4638 by 2:30 p.m. in London, from $1.4784 yesterday. It was at 86.54 pence per euro, from 86.01, after weakening to a record low of 86.96 pence.

Central banks are stepping up rate cuts to revive economies battered by the ravages of a collapse in bank lending that’s frozen credit markets around the world.

“Conditions in money and credit markets remain extremely difficult,” the Bank of England said in a statement accompanying today’s decision. “The committee noted that it was unlikely that a normal volume of lending would be restored without further measures.”

Going to Zero

The European Central Bank lowered its benchmark rate by 0.75 percentage point today, the biggest cut since the euro’s debut in 1999. Sweden’s Riksbank cut its rate by the most since 1992. New Zealand policy makers reduced theirs by a record and Bank Indonesia also lowered its rate today.

Today’s interest-rate cut “was disappointing and behind the curve,” said Neil Jones, head of European hedge-fund sales in London at Mizuho Capital Markets. “There’s no point in saving bullets when there is nothing left to shoot. The impact on sterling will be negative.”

The U.K. benchmark may fall to zero early next year, forcing officials to consider other means of restarting bank lending and reviving the economy, former policy maker Willem Buiter said this week.

“Those currencies that are moving toward zero interest rates will suffer until they reach zero,” Jones said. “We are in a transition.”

Expectations for U.K. inflation over the next decade rose today, with the difference in yield, or spread, between the 10- year gilt and its index-linked counterpart climbing three basis points to 0.98 percent. The gauge was at a record low of 0.80 percent on Dec. 2, after peaking at 4.16 percent on July 7.

Reduced Bets

Interest-rate futures rose for the first time in six days as traders reduced wagers on cuts in borrowing costs. The yield on the contract expiring in March rose eight basis points to 2.31 percent. The yield was 3.24 percent a month ago.

U.K. home values declined 2.6 percent from October, HBOS Plc said today. In the three months through November, prices fell 14.9 percent from a year earlier. Reports yesterday showed U.K. services shrank at the fastest pace in at least 12 years and consumer confidence worsened.

The Bank of England lowered its key rate five times this year to shield the British economy from the global credit crisis, sending the pound 26 percent lower against the dollar, the most since at least 1972. It cut the benchmark rate by 1.5 percentage points last month.

Backed Up

The pound will weaken to $1.36 by the end of the year and to $1.24 by the end of the first quarter, while staying at around 86 pence to the euro in the same period, Stannard said.

U.K. two-year government bonds fell after the Bank of England decision, erasing earlier gains. The yield on the two- year gilt, which earlier dropped to a 16-year low of 1.57 percent, rose eight basis points to 1.75. The 10-year pared gains, the yield falling four basis points to 3.38 percent. Yields move inversely to bond prices.

“The statement sounds more neutral than the market had hoped for and that’s why yields at the front backed up,” said Jason Simpson, a fixed-income strategist at Royal Bank of Scotland Group Plc, one of the 15 so-called Gilt-Edged Market Makers which deal directly with the Treasury. “The outlook for the U.K. economy is still pretty grim, and there’s no doubt about that. But gilts yields at the current levels would need a more dovish statement to go lower.”

To contact the reporters on this story: Gavin Finch in London at gfinch@bloomberg.net; Matthew Brown in London on mbrown42@bloomberg.net