Sterling hits new lows as recession fear bites

Growth forecasts for next year slashed, interest rates expected to hit zero
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A run of exceptionally poor economic news suggesting that Britain is heading for a deeper and longer recession than previously feared helped push sterling to record lows yesterday.

Expectations that the Bank of England would soon cut interest rates to zero, or close to it, drove investors to other currencies, particularly the euro. The pound fell to below €1.14 for the first time, with €1 buying 87.7p – the highest since the single currency was launched in 1999.

Sterling touched new lows against a trade-weighted basket of currencies. It has depreciated by more than 20 per cent over the past year, though this has so far failed to boost exports, with the trade deficit widening in October.

Chris Gothard, a currency analyst at Brown Brothers Harriman, said: "We have declining interest rates and there isn't really anything at the moment to provide a strong reason to buy."

Glenn Uniacke, a dealer at the currency specialist Moneycorp, said a report from the National Institute of Economic and Social Research which estimated GDP had fallen by 1 per cent over the three months to the end of November had also worried investors.

"Those figures are the most concerning in a long series of poor data on the UK economy and have left us on the brink of a sterling crisis," he said.

"The economy has the potential to shrink by 2 per cent next year and interest rates are likely to be cut towards zero per cent. This could push the pound towards parity with the euro, which is particularly worrying for a country so reliant on imports. Through exchange rate movements alone, the UK is now paying 20 per cent more for eurozone imports than a year ago. While the EU and Japan led the world into recession, the problems facing the UK are far more acute."

Interest rates have been cut both in the UK and in the eurozone but they remain higher in the euro currency area and most economists believe that the Bank of England will be bolder in reducing the cost of borrowing than the European Central Bank over the next few months. The markets will also have noted the parlous state of the UK's public finances, epically compared with those in Europe's largest economy, Germany.

Alistair Darling, the Chancellor, said yesterday that he was not prepared to give a "running commentary" on the pound. "Exchange rates right across the world have been pretty volatile, very volatile in fact," he said.

"The depreciation clearly does help our exporters. But currencies have been pretty volatile over the last few months. Our policy, the Bank of England's policy, is to target inflation, not to target the currency."

Mr Darling's words did not reassure many, especially given the figures from the national research institute showing that the economy had shrunk by 1 per cent. The respected independent think-tank's record on predicting move-ments in the economy is an enviable one. Survey data from the CBI, the Chartered Institute of Purchasing and Supply and other sources suggest that the economy has, in the words of one analyst this week, "fallen off a cliff" over the past month or so.

Despite signs that consumers are responding to the VAT cut and treating themselves to "one last fling", the outlook is gloomy. The office for National Statistics revealed on Tuesday that manufacturing output was heading for its worst year since the recession of 1979-81.

The Global Insight economist Howard Archer said: "The plethora of bad data and survey evidence relating to retail sales, unemployment, service sector activity, manufacturing output and construction activity highlight that the economy has taken a big turn for the worse." He expects the economy to decline by 2 per cent in 2009.