Pound Gains as BOE Lowers Rate to Record Low to Revive Economy

By Matthew Brown

Jan. 8 (Bloomberg) -- The pound rose against the euro and the dollar after the Bank of England cut its benchmark interest rate to an all-time low of 1.5 percent to limit the fallout from Britain’s first recession in 17 years.

The Monetary Policy Committee, led by Governor Mervyn King, lowered the rate by 50 basis points, in line with economists’ predictions. It was the central bank’s fourth cut since the global coordinated emergency reductions on Oct. 8.

“Half a point is less than hoped for by traders, the market is disappointed,” said Neil Jones, head of European hedge fund sales in London for Mizuho Corporate Bank. “This may lead to a rise in sterling immediately on interest-rate differentials, but I think it will do damage to the pound in the longer term.”

The pound advanced as much as 1.6 percent to 88.94 pence per euro before trading at 89.29 pence as of 1:24 p.m. in London, from 90.35 pence yesterday. It was 1.1 percent higher at $1.5254 from $1.5095.

Any U.K. rate cut today would have brought borrowing costs to the lowest since the Bank of England’s foundation in 1694. The European Central Bank trimmed its key interest rate by 1.75 percentage points to 2.50 percent since early October and may reduce it again next week.

“The availability of credit to both households and businesses has tightened further, pointing to the need for further measures to increase the flow of lending to the non- financial sector,” the Bank of England said in a statement accompanying today’s decision. “Output is likely to continue to fall sharply during the first part of this year.”

Record Low

The pound lost 23 percent against the euro last year as U.K. policy makers cut rates faster than their ECB counterparts. The Bank of England lowered the key rate by 4.25 percentage points since December 2007, while the ECB cut its rate by 1.5 percentage points in the same period.

Sterling weakened to a record 98.03 pence per euro Dec. 30 on expectations the central bank would continue to cut rates faster than the ECB.

“They’ll come down below 1 percent by the second quarter,” said Philip Shaw, chief economist at Investec Securities in London. “Things have deteriorated further and this highlights the need for further monetary stimulus. Quantitative easing or non-conventional monetary policy techniques are on the cards.”

Interest-Rate Bets

Traders raised bets today on further interest-rate cuts, with short sterling futures for March delivery falling to 1.65 percent, from 1.69 percent yesterday.

“The substantial depreciation in sterling over recent months may help to moderate the impact on U.K. net exports of the slowdown in global growth,” the Bank of England said.

The pound may extend gains against the dollar, Ashraf Laidi, chief currency strategist at CMC Markets in London, wrote in a research note after the decision. “Sterling has already knifed through our projected resistance of $1.52, making yesterday’s $1.5280 high a less challenging target, especially amid potentially negative U.S. jobs data ahead.”

Chancellor of the Exchequer Alistair Darling signaled in an interview with the Financial Times that the U.K. Treasury may need to play a bigger role in setting monetary policy if interest rates approach zero.

The government is “looking at what else we would need to do,” Darling said in the Financial Times interview published today. “The closer interest rates come down to zero, the more the normal transmission mechanism and the operation of monetary policy has to be looked at.”

No ‘Supportive Environment’

If the Treasury embarks on quantitative easing, the government may authorize the central bank to buy assets including government securities and even print money to pay for them, according to analysts.

“Attention will now turn steadily to the Bank’s appetite for a policy of quantitative easing,” said Neil Mellor, a currency strategist in London at Bank of New York Mellon Corp., the world’s largest custodian of financial assets. “It can hardly be said that this provides a supportive environment for pound.”

U.K. government bonds rose, pushing the yield on the 10- year gilt down seven basis points to 3.22 percent. The 5 percent security due March 2018 added 0.56, or 5.6 pounds per 1,000- pound face amount, to 114.06. The two-year gilt yield was at 1.67 percent.

To contact the reporter on this story: Matthew Brown in London at mbrown42@bloomberg.net