U.K. Pound Falls to 22-Month Low as BOE Slashes Growth Forecast

By Kim-Mai Cutler and Andrew MacAskill

Aug. 13 (Bloomberg) -- The U.K. pound fell to a 22-month low against the dollar and government bonds advanced after the Bank of England cut its growth forecast and held out the prospect of lower interest rates.

The pound weakened for a ninth straight day as Bank of England Governor Mervyn King said he saw a ``chill in the economic air'' after unemployment rose in July by the most in almost 16 years. The currency's 7.6 percent decline since July 31 is its largest since February 1993, when Britain was emerging from two years of recession.

``The consensus was he was going to be a bit more handcuffed by inflation,'' said John Hardy, the head of foreign- exchange strategy at Saxo Bank A/S, a Copenhagen-based bank specializing in currencies, stocks, bonds and derivatives. ``So for sterling there is going to be some downside.''

The British currency fell to $1.8676 by 3:11 p.m. in London, the lowest level since October 2006, from $1.8968 yesterday. It was as high as $2.0157 three weeks ago. The pound also declined to 79.56 pence per euro, from 78.69 pence.

Not since July 2005, when slowing economic growth and falling house prices presaged a cut in interest rates the following month, has the pound dropped for nine consecutive days against the dollar. This month, it weakened more than any other currency except the South African rand and Australian dollar.

`Chill in Air'

The depreciating currency underlines concern that a slumping housing market is pushing Europe's second-biggest economy toward a recession. A drop in house prices in July brought the property market to a ``virtual standstill,'' the Royal Institution of Chartered Surveyors said yesterday. The economy will grow about 0.1 percent on a year-on-year basis in the first quarter of 2009, compared with a previous prediction of 1 percent, according to bank forecasts published today.

``It may still be summer but there is a feeling of chill in the economic air,'' King said at a press conference in London following the release of the central bank's quarterly inflation report. The economy faces a ``difficult and painful adjustment'' that ``cannot be avoided. As a result inflation is rising and growth is slowing.''

Inflation may accelerate above 5 percent before slowing to just below the central bank's 2 percent ceiling in two years if interest rates stay on hold, as investors predict, according to the central bank.

Traders raised bets the bank will cut interest rates this year, with the implied yield on the December sterling interest- rate futures contract tumbling 23 basis points to 5.51 percent. The bank's benchmark interest rate is 5 percent.

Relative Strength Index

Technical indicators suggested the pound may be poised to rebound, with the currency's 14-day relative strength index versus the dollar falling to 16.62. A level below 30 typically signals a change in price direction.

Government bonds rose, with the yield on the 10-year gilt falling 2 basis points to 4.62 percent. The price of the 5 percent security due March 2018 climbed 0.14, or 1.4 pounds per 1,000-pound ($1,866) face amount, to 102.96. The yield on the two-year gilt, which is more sensitive to the outlook for interest rates, dropped 15 basis points to 4.51 percent. Bond yields move inversely to prices.

``Gilts are flying on the back of a much more-dovish-than- expected inflation report,'' said Nick Stamenkovic, a fixed- income strategist at RIA Capital Markets in Edinburgh. ``This implies the next move in rates will be down, possibly as early as November.''

Employment Report

U.K. claims for jobless benefits climbed 20,100 from June to 864,700, the biggest increase since December 1992, the Office for National Statistics said today in London. Incomes rose the least in five years.

``Overall the market will be looking through this peak of inflation and at the deteriorating growth prospects,'' said Ian Stannard, a London-based currency strategist for BNP Paribas SA. ``That is going to be enough to put sterling under pressure.'' The pound may fall to $1.85 by year-end, Stannard said.

Investors turned more bearish on the pound this month, a survey of Bloomberg users showed. An index of expectations dropped to 37.73 from 42.41, according to respondents in the monthly Bloomberg Professional Global Confidence Index, which questioned 2,969 users from Los Angeles to Paris to Tokyo.

The pound's decline against the dollar has driven it below the level at which analysts expect it to end the year. The pound will be at $1.91 and 80 pence per euro by year-end, according to the median forecast of analysts and strategists surveyed by Bloomberg. The yield on the 10-year note will end the year at 4.87 percent, according to a separate survey.

The pound fell 7.5 percent against the euro this year. It's down 5.4 percent versus the dollar, after being little changed against the U.S. currency as recently as July 31.

To contact the reporters on this story: Kim-Mai Cutler in London at kcutler@bloomberg.net; Andrew MacAskill in London at amacaskill@bloomberg.net

Last Updated: August 13, 2008 10:34 EDT