Following on from last week, the Pound plummeted to a fresh record low against the Euro, while the UK currency briefly sank under $1.4500 versus the Dollar as 10-year government bonds rose by the most in a decade following the Bank of England’s decision to cut interest rates to the lowest level since 1951.
The monetary policy committee, led by the governor Mervyn King, took the decision to slash UK interest rates by 100 basis points to 2% as the global financial crisis sent the banking system into meltdown and pushed the UK economy into a recession.
The government and the Bank of England are doing “whatever is necessary” in limiting the impact of the economic slump and together with the cut in value added tax, the aggressive reduction in borrowing costs is designed to spur consumer spending and improve lending conditions.
In the aftermath of the decision, the Prime Minister Gordon Brown stepped up pressure on British banks to pass on the full extent of the reduction in borrowing costs as three lenders resisted mounting demands to cut variable rates.
The dramatic cut in UK interest rates is relatively pointless in reviving sentiment unless banks and lenders cut their lending rates in accordance with the Bank of England but Halifax, the Royal Bank of Scotland Plc and Nationwide Building Society only slashed their main mortgage rates by less than one point.
Lloyds TSB Group Plc and HSBC Holdings Plc both passed on the full cut and speaking on GMTV, Brown told banks that refusal to pass on the rates cuts was “not acceptable” and the Prime Minister also recognises that in order to kick-start the economy he must get banks to lend and stop rationing mortgages in the UK.
Lenders approved just 32,000 new mortgages in October, a third of the 104,000 monthly average last year but the government has pledged to buy controlling stakes in RBS, Lloyds TSB and HBOS in exchange for assurances to boost lending volumes and lowerthe cost of credit.
The Pound slipped under 1.1500 against the Euro for the first time on record in the build up to the announcement and the UK currency extended losses against all but one of the 16 most actively traded currencies amid suggestions that interest rates could be lowered to zero per cent.
The extent of last week’s cut in rates was largely in line with initial forecasts but an element of risk aversion crept back into the market as the 1% reduction highlighted the persistent problems surrounding the outlook for the UK economy and led investors flocking back to ‘safe haven’ assets like the Dollar and Yen.
Over the course of last week, the Pound lost a further 4.6% in value and a number of politicians and policy makers have expressed concerns that although the decline in sterling was necessary to revive growth, the government is running the risk of a collapse in the UK currency.
Recent estimates from the Organisation for Economic Cooperation and Development showed that UK gross domestic product contracted 0.5% in the three months through September and may shrink by 1.1% in 2009, the most since the last recession in 1991.
UK services accounts for roughly 90% of the economy and the monumental drop in spending has been emphasised by the decline in the housing market as home values slumped 2.6% in November, to record the biggest drop since 1992, and 16.1 from this stage in 2007.
The negative sentiment surrounding the Pound is likely to continue over the coming week as risk aversion saturates the market, while in terms of economic data, the focus will fall on UK producer prices data this morning and the report should offer further evidence of easing inflationary pressures.
The Euro continued to make record gains against the Pound last week despite another 75 basis point cut in European interest rates but the ECB Chairman Jean-Claude Trichet is under pressure to outline a plan to revive the economy or risk cutting interest rates to zero per cent.
The Central Bank has implemented the most aggressive series of rate cuts in its history but policy makers have failed to spell out a specific plan should conventional methods fail to head off deflation.
It is a relatively quiet week in terms of economic data and the focus this week in the Euro-zone will inevitably fall on the German ZEW expectations index for December and the report is forecast to slip again after the previous month’s surprising increase.
The Dollar posted another weekly decline against the Euro and Japanese Yen and the move was exacerbated on Friday as U.S non-farm payrolls in the U.S shrank by 533,000 in November, the 11th month that companies have cut jobs and a damning assessment of the deteriorating labour market conditions.
The U.S economy may be headed towards its deepest and most prolonged recession since the Second World War as mounting job losses weigh on consumer confidence and spending as employers cut payrolls at the fastest pace in 34-years with unemployment rising to 6.7%.
Source: TorFX
