The news that the British economy remains deep in recession, contracting by a further 0.4 per cent in the third quarter, had a devastating impact on the value of sterling yesterday.
The data, which far exceeded even the gloomiest City economists' estimates of growth, sent the pound plunging in its largest fall against the euro in six months, as it dropped 1.5 per cent during the day to €1.0887.
More ominously, sterling also fell against the dollar, which is suffering a prolonged bout of weakness as doubts gather over its future as a reserve currency, recently revealed in The Independent. The pound fell by 1.5 per cent against the dollar, to $1.6345.
Traders were reacting to the increased likelihood that the Bank of England will boost its policy of quantitative easing when the Monetary Policy Committee (MPC) makes its next announcement on 5 November.
The Bank is close to completing its £175bn programme of purchasing gilts and smaller quantities of corporate bonds and commercial paper. The aim has been to push gilt yields lower, thus making other investments – such as equities and debt securities – more attractive, helping companies to raise new capital through rights issues, and generally boosting capital markets and asset values.
Analysts believe about half the improvement in the markets seen since the last meltdown in March can be attributed to the Bank's policy. The trend to lower sterling interest rates combined with longer-term inflation worries have pushed the pound lower.
Signs of renewed weakness in the economy will bolster the case of those on the MPC who have already indicated their willingness to expand the QE programme. At the August meeting of the MPC, the Bank of England Governor Mervyn King and two others found themselves in a minority when the MPC voted to expand QE by £50bn rather than £75bn. The chances that the Governor will get his way at the next meeting have sharpened considerably since the weak GDP data was published by the Office for National Statistics.
November would be a strong contender for a change in policy as the Bank's quarterly Inflation Report, its definitive view of the economy, is launched a few days later. The report usually gives the Bank's economists scope to explain their policies in detail. Analysts also expect interest rates to remain at their current lows for longer, and for the Bank to take steps to encourage the banks to lend more by reducing the remuneration they receive on their reserves held at the Bank of England.
Malcolm Barr, an economist at JP Morgan, said: "Given this news, we are revising our forecast to anticipate a £50bn extension in QE alongside reserve remuneration changes.
"The MPC was already concerned that the prospective recovery in output would be insufficient to begin to absorb slack and prevent an inflation undershoot: those concerns will be heightened by this data."Reuse content