By Agnes Lovasz Oct. 7 (Bloomberg) -- The British pound weakened against the euro after U.K. factory production contracted for a sixth month in August, fueling speculation the credit crisis has plunged the economy into a recession. The currency snapped a three-day gain versus the euro as a report showed manufacturing output fell 0.4 percent from July and U.K. lenders held talks with the government on emergency funding. The slump will prompt the Bank of England to cut its key interest rate by a quarter point to 4.75 percent in two days, a Bloomberg survey showed. Policy makers ``need to take a more aggressive step than the market is expecting on the back of strains within financial markets, the significant deterioration of U.K. economic data and potentially recessionary conditions,'' said Kamal Sharma, a currency strategist in London at JPMorgan Chase & Co. ``There is an expectation the Bank of England may cut by more than 25 basis points this week, which is weighing on sterling.'' The pound weakened to 77.75 pence per euro as of 5:27 p.m. in London, from 77.42 pence yesterday. It climbed to $1.7534, after earlier falling to $1.7319, the lowest level since March 2006, from $1.7441. The 14-day relative strength index of the pound against the dollar dropped to 31.6 yesterday, close to the 30 level that signals the currency may be poised to rebound. The index is a technical chart used by traders to indicate when the price of a currency or asset is about to change direction. Bank Investment The U.K. government may invest at least 45 billion pounds ($79 billion) in banks including Royal Bank of Scotland Group Plc and Barclays Plc to bolster capital depleted by mortgage-related losses, three people with knowledge of the situation said. Chancellor of the Exchequer Alistair Darling and Bank of England Governor Mervyn King met with banking chief executive officers including RBS's Fred Goodwin and Barclays's John Varley late yesterday to discuss the investment, said the people, who declined to be identified because the meeting was confidential. Barclays and Royal Bank of Scotland said they didn't request capital from the government. Prime Minister Gordon Brown will meet authorities overseeing financial institutions later today to discuss action to help banks stricken by the credit crunch. Traders added to bets on a rate cut by the Bank of England at its meeting Oct. 9. The implied yield on the March short-sterling futures contract declined 26 basis points to 4.24 percent. It was 4.72 percent at the end of last week. Rate Calls Policy makers should cut the key rate half a point to 4.5 percent after business confidence suffered an ``alarming'' drop in the past quarter, the British Chambers of Commerce said today. Sentiment, based on a survey of almost 5,100 companies, fell to the lowest since the data began in 1989, the London-based lobby group said. Indexes measuring sales in services and manufacturing, making up 90 percent of the economy, showed contraction at a faster pace than in the second quarter. British two-year government notes rose, pushing the yield 7 basis points lower to 3.60 percent. The 4.75 percent bond due June 2010 gained 0.11, or 1.1 pounds per 1,000 pound ($1,753) face amount, to 101.84. The 10-year gilt yield climbed 2 basis points to 4.24 percent. The U.K. Debt Management Office today sold 1.2 billion pounds of 1.875 percent inflation-linked securities due in November 2022. Investors bid for 1.12 times the bonds offered, compared with 1.58 times at the previous auction on June 10. To contact the reporter on this story: Agnes Lovasz in London at alovasz@bloomberg.net

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