BLBG: U.K. Pound Weakens Most Since at Least 1971 as Economy Shrinks
By Kim-Mai Cutler
Oct. 24 (Bloomberg) -- The pound tumbled below $1.53 in its biggest drop in at least 37 years after a report showed the U.K. economy contracted more than forecast in the third quarter, bringing the nation to the brink of a recession.
The 5.9 percent intraday decline surpassed that of Black Wednesday in September 1992, when the U.K. was driven out of Europe's Exchange Rate Mechanism. Gross domestic product shrank in the three months through September by more than twice as much as analysts predicted, a report showed today, putting the economy on course for its first recession since 1991. The FTSE 100 index slumped as much as 9.1 percent and the yield on the 10-year gilt headed for its biggest weekly decline in almost nine years.
``This is once-in-a-lifetime stuff, we're all sat under our desks with tin hats on,'' said Neil Mellor, a currency strategist in London at Bank of New York Mellon Corp. ``The U.K. is in the first step toward a recession and the dollar's bid because of repatriation flows.''
The U.K. currency fell to $1.5269, the lowest level since August 2002, and traded 2.8 percent lower at $1.5875 at 4:59 p.m. in London, from $1.6230 yesterday. Against the euro, the pound weakened to a record 81.96 pence, dropping for a fifth day, before trading at 79.93 pence, from 79.69 pence.
A collapse in credit markets and the worst housing slump in a generation have buffeted the British economy, Europe's second- biggest. The U.K. is already in a recession and the economy will contract for the next three quarters, Ernst & Young's ITEM Club, which uses the same forecasting model as the Treasury, said in a report on Oct. 20.
`Black Wednesday'
The economy shrank 0.5 percent in the third quarter, the Office for National Statistics in London said today. The median forecast of 35 economists in a Bloomberg survey was for a contraction of 0.2 percent.
Today's drop in the pound brought the decline this week to 8.5 percent, the most since the week that included Black Wednesday on Sept. 16, 1992, the day U.K. Prime Minister John Major pulled the pound out of the Exchange Rate Mechanism. The currency lost 9.8 percent that week.
The pound fell as much at 5.9 percent, the largest intraday drop since at least 1971, when former U.S. President Richard Nixon suspended the dollar's convertibility into gold and ended the global fixed exchange-rate regime set up at the Bretton Woods conference at the end of World War II.
``These moves are absolutely without precedent,'' said David Watt, a Toronto-based currency strategist at Royal Bank of Canada Ltd. ``The 1970s are pretty much the extent of the data you're going to get because currencies didn't even float that far back.''
$1.40s `Soon'
Volatility on one-month pound-yen options, a measure of expectations for future price swings, rose to 47.24 percent, the highest on record, indicating greater risk market moves may erode profits. The pound has lost 15 percent against the yen this week.
The pound may fall to the $1.40s ``very soon,'' said Hans- Guenter Redeker, London-based global head of currency strategy at BNP Paribas SA, the most accurate forecaster in a 2007 Bloomberg News survey.
``It has a lot to do with the underlying conditions in the British economy and how the situation in Europe as a whole is currently developing,'' Redeker said today in an interview on Bloomberg television.
House prices will continue to fall and the pound may depreciate further, Bank of England Governor Mervyn King said in a speech to executives in Leeds, England on Oct. 21.
Prime Minister Gordon Brown predicted the next day that the U.K. will slip into a recession for the first time since he took charge of Britain's finances in 1997. The remarks were Brown's first admission that the country's longest unbroken streak of economic growth in more than a century is over.
Rate-Cut Bets
``The combination of a squeeze on real take-home pay and a decline in the availability of credit poses the risk of a sharp and prolonged slowdown in domestic demand,'' King said. The Monetary Policy Committee ``will act promptly to ensure that inflation remains on track to meet our target.''
For the U.K. economy, the pound's drop will benefit manufacturers including Nissan Motor Co. and Ford Motor Co., which have factories in Britain, and help bring about the ``rebalancing'' that King has said for years is needed.
Earlier this week, King signaled he expected sterling to weaken further, noting that investors may be losing their appetite for U.K. assets because of the approaching recession, drying the amount of funds flowing into London banks.
``Unless they are replaced by other forms of external finance, the adjustments in the trade deficit and exchange rate will need to be larger and faster than would otherwise have occurred, implying a larger rise in domestic saving and weaker domestic spending in the short run,'' King said.
Bonds Jump
The chances that the Bank of England will lower its benchmark interest rate by as much as three-quarters of a percentage point by year-end rose to 30 percent today, a Credit Suisse Group AG index of derivatives showed. The odds of a cut of that magnitude were 5 percent yesterday.
Government bonds rose, with the yield on the two-year gilt falling 17 basis points to 3.08 percent. The 4.75 percent note maturing June 2010 climbed 0.25, or 2.5 pounds per 1,000-pound ($1,588) face amount, to 102.60. The yield on the 10-year security dropped 11 basis points to 4.36 percent, on course for its biggest weekly decline since 1999. Bond yields move inversely to prices.
To contact the reporter on this story: Kim-Mai Cutler in London at kcutler@bloomberg.net
