Pound sinks into unplumbed depths

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The Independent Online

Economics Correspondent

The pound fell into uncharted territory yesterday, sailing perilously closer to the crucial DM2 barrier. It hit an all-time low against both the mark and a range of other currencies in heavy trading.

"Sterling is completely out of favour due to a deadly combination of political worries and firmer expectations of an interest rate cut," said Neil MacKinnon, chief economist at Citibank in London. He predicted the pound could fall from the DM2.1725 low it touched yesterday to DM2 in the next few months.

Howard Davies, the Bank of England's deputy governor, said yesterday that it would change its advice on interest rates if there were clear signs that the economy had weakened. This was the clearest signal so far that recent weak data might alter the Bank's current "wait and see" policy on base rates.

However, Mr Davies added: "We are not yet persuaded that inflation is dead, nor indeed that the Government will achieve its inflation target of 2.5 per cent or less." Some indicators were pointing up, some down.

Figures released earlier this week cemented expectations that the Chancellor will cut base rates soon after the Budget on 28 November. Last month unemployment rose for the first time in two years, manufacturing output and retail sales volumes fell, while inflation declined unexpectedly.

Traders in the short sterling futures market are currently betting that interest rates will drop by a quarter point from their current level of 6.75 per cent by the end of this year, and again in the first half of next year. The only reasons analysts can see to postpone a reduction would be either an irresponsible Budget or an even sharper fall in the pound.

Sterling recovered a fraction against the mark but its index against a range of currencies closed at a record low of 82.3 yesterday. It has fallen nearly 8 per cent since the beginning of this year.

The past week has seen the promise of interest rate cuts move closer not only in Britain but also in America and Germany. There is mounting evidence of slower growth and lower inflation than anyone expected in all the industrial countries, building a persuasive case for a relaxation of policy. With budget-cutting a high priority in both the US and Europe, interest rates will have to take the strain.

Ian Harwood, an economist at Kleinwort Benson, said: "The question of which direction growth is heading has been the key issue for the past six months. It is increasingly clear now that it is getting weaker."

The US economy has shown no signs of picking up in reaction to the Federal Reserve's last reduction in interest rates, in July. The mid-year pause in growth has proved to be a long halt. The policy outlook is complicated by the farcical budget clash in Washington, but many Wall Street analysts think the Fed will cut rates before the end of the year. This would make it easier for UK rates, which tend to follow the US, to fall too.

German interest rates could have to wait a litle longer.