Pound Sterling Plummets as the Chance for a BOE Rate Cut Improves

By Jason Simpkins
Associate Editor

The British pound fell to a 22-month low yesterday (Wednesday), after the Bank of England (BOE) offered a gloomy outlook for the U.K. economy and the chance of an interest rate cut increased.

The pound fell to $1.8656 yesterday – its lowest level since October 2006 – from 1.8968 the day prior. The British currency has fallen 5.4% against the dollar so far this year, and 7.6% against the dollar since the end of July. The pound is down 7.5% against the euro this year.

The decline has been prompted by a perceived shift in BOE policy, as many analysts see the central bank as shifting its focus from inflation to declining growth. 

Inflation is yesterday’s story and UK growth is falling to pieces,” David Bloom of HSBC Bank (ADR: HBC) told the Financial Times. “The pound is going to get absolutely thrashed.”

The BOE has held its rates steady since April in an effort to subdue inflation, which hit a decade-high 4.4% in July. But the central bank struck an ominous chord when it lowered its growth forecast for the first quarter of 2009 and said inflation would be below 2% by 2010.

The BOE said the economy would grow 0.1% year-over-year in the first quarter of 2009, compared to its previous growth forecast of 1%.

Analysts at both BNP Paribas SA (OTC: BNPQY) and JPMorgan Chase & Co. (JPM) have moved up their predictions for an interest rate cut, and said the Bank of England could cut its benchmark rate as early as November of this year.

A sharp rise in unemployment, which rose for a sixth straight month in June, has emerged as the predominant threat to the British economy. The jobless rate hit 2.7% in June, up from 2.6% the month prior. Unemployment, as measured by International Labor Organization standards could rise by 25% to more than 2 million, Bloomberg News reported.  ILO-based unemployment jumped to 5.4% in the second quarter, the highest level in close to a year.

The International Monetary Fund last week predicted U.K. economic growth would grow by 1.4% in 2008 and 1.1% in 2009, down from its previous estimate of 1.8% for 2008 and 1.7% for 2009.

“It may still be summer but there is a feeling of chill in economic air,” said BOE Governor Mervyn King. “The British economy is going through a difficult and painful adjustment.”

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