LONDON (MarketWatch) - The euro and the British pound slipped for a second day Thursday as markets braced for potentially big rate cuts by the European Central Bank and the Bank of England.
Increasingly bleak economic data from the U.K. and the 15-nation euro zone have led traders to expect at least a cut of at least 100 basis points, or a full percentage point, by the Bank of England and 50 basis points by the Frankfurt-based ECB.
"Aggressive cuts are widely expected by both parties and this has been factored into prices, so look for volatility initially if we don't see the anticipated 100-point cut in the U.K. and a 50-point cut in the euro zone," said James Hughes, a strategist at CMC Markets.
A cut of a full percentage point by the Bank of England's Monetary Policy Committee would leave the key lending rate at 2%. In the central bank's 300-year-plus history, the benchmark rate has never been set below 2% and was last at that level in 1939.
A half-point cut by the ECB's Governing Council, which is meeting this month in Brussels, would take the central bank's key lending rate to 2.75%. Credit markets have increasingly factored in a 75-basis-point cut.
The Bank of England will announce its rate decision at 7 a.m. U.S. Eastern. The ECB will announce its decision at 7:45 a.m. Eastern, followed by ECB President Jean-Claude Trichet's monthly news conference at 8:30 a.m. Eastern. See full story.
Interest-rate cuts are typically bearish for a currency because they reduce the yield on assets denominated in the currency. Foreign-exchange markets also factor in other considerations, including the impact of rate moves on the economic outlook.
Regardless of the size of Thursday's rate moves, both the Bank of England and the ECB are expected to further cut rates aggressively in coming months.
Although the U.S. Federal Reserve was quicker to cut interest rates sharply, the U.S. dollar has rebounded strongly against the euro and the British pound this year.
The currency's gains have stemmed in part from massive de-leveraging and liquidation of foreign holdings, but have also been attributed partly to ideas that the U.S. economy may bottom out before other major economies.
The dollar index , which tracks the performance of the dollar against a trade-weighted basket of six major currencies, rose to 87.412 from 86.811 in late North American trading Wednesday.
The euro bought $1.2604, down from $1.2700 late Wednesday. The British pound fell to $1.4529 from $1.4768.
The dollar lost ground against the Japanese currency, declining to 92.81 yen from 93.14 yen.
The euro was on the rise versus the British pound, meanwhile, gaining 0.8% to 86.72 pence.
The potential for further sharp rate cuts by the Bank of England and ECB will likely leave the pound at a disadvantage, said Simon Derrick, currency strategist at Bank of New York Mellon.
The pound has typically been a particularly interest-rate sensitive currency, he said, noting a 93% correlation between the performance of the euro/British pound currency pair and the two-year yield spread between German and U.K. government bonds.
The yield gap has widened by more than 40 basis points in favor of the euro-denominated bonds since the end of last month, Derrick said in a research note.
And with the Bank of England likely to prove more aggressive in cutting rates in coming months, "the suspicion must be that [the pound] will weaken further against the euro," with the single currency potentially strengthening to 90 pence or beyond "relatively swiftly from here," he said.
Meanwhile, Sweden's Riksbank on Thursday surprised markets by slashing its repo rate 1.75 percentage points to 2%. Economists had anticipated a cut of around one percentage point after the central bank announced Monday that it had moved up its December meeting by two weeks.
The Swedish krona fell 1.5% against the European single currency to trade at 10.554 per euro.
Earlier Thursday, New Zealand's central bank cut its official cash rate from 6.5% to 5% -- a five-year low.
New Zealand Reserve Bank Gov. Alan Bollard cited "ongoing financial market turmoil and the marked deterioration in the outlook for global growth" as key factors in the decision.
The New Zealand dollar rose 0.3% against the U.S. dollar to trade at NZ$1.8709 in recent trade.
