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Sterling was hammered down to a five-year low against the dollar this morning after Mervyn King admitted for the first time that the UK is entering a recession.
The pound began tumbling last night as the Bank of England governor told business leaders in Leeds that the economy is shrinking and hinted at fresh interest rate cuts.
By this morning it had fallen by seven cents to $1.6209, a drop of more than 4%. Traders reported frantic selling as investors rushed to cut their losses by selling the UK currency.
Shares also fell sharply in London this morning, with the FTSE 100 shedding over 100 points, or 2.3%, in early trading to 4127.29.
Sterling had already been hit yesterday by unexpectedly gloomy manufacturing data showing that confidence has collapsed, and King's comments appear to have added to concern over quite how weak the British economy now is.
Describing the banking system turmoil of recent weeks as "extraordinary, almost unimaginable," he said the financial system had come closer to collapse two weeks ago than at any time in the past 90 years.
"The combination of a squeeze on real take-home pay and a decline in the availability of credit poses the risk of a sharp and prolonged slowdown in domestic demand. Indeed, it now seems likely that the UK economy is entering a recession," King said.
"It is surely probable that the drama of the banking crisis, which is unprecedented in the lifetime of almost all of us, will damage business and consumer confidence more generally."
His fears were confirmed yesterday as the CBI reported that confidence among British manufacturers had tumbled to its lowest since July 1980, with output and orders also collapsing.
The thinktank the National Institute for Economic and Social Research said today that Britain entered a recession in the third quarter of the year and warns the slump will probably last for a year or more, making it every bit as painful as the recessions of the early 1990s or early 1980s.
City commentator David Buik said that King's speech has "put sterling to the sword for the time being".
The Bank of England cut the cost of borrowing by half a point to 4.5% earlier this month, as part of coordinated global action, and King hinted that rates may come down again soon.
"During the past month, the balance of risks to inflation in the medium-term shifted decisively to the downside," he said.
While sterling wilted, the US dollar hit a two-year high against a basket of currencies this morning. Speculation of interest rate cuts across Europe have made the greenback more attractive - after months in which traders bet against the dollar.
Official data out on Friday will almost certainly show that the economy contracted in the July to September period, having not grown at all in the second quarter. A "technical" recession is defined as two consecutive quarters of contraction, which experts say is the least Britain can expect this time round.
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