Recession alert sends pound to five-year low

[Legal Beagles]

The pound fell to its lowest level in five years against the dollar yesterday after Bank of England governor Mervyn King's warning that the economy was entering a recession caused a flight from sterling.
At one point the pound fell to just above $1.62, a 19% drop from the $2 a pound would buy as recently as July and the lowest level since late 2003. It had fallen 3% on the day and is now on course for its biggest weekly fall since being ejected from the European exchange rate mechanism in 1992.
The pound is 25% lower against the dollar than a year ago and 16% lower against the euro at around 79p.
The pound's fall will mean dearer holidays for Britons travelling abroad but will make British firms' exports cheaper in foreign markets. It will also blunt some of the impact of falling oil prices, which are denominated in dollars, on the price of petrol at the pump.
King acknowledged in a speech late on Tuesday that the economy was facing the risk of a "sharp and prolonged slowdown in domestic demand" and was probably already in recession. He became the first senior official to admit what many economists have been saying for a while.
"King didn't really say anything we didn't already know, but if people were looking to sell sterling then it was as good an excuse as any," said Neil Mellor, strategist at Bank of New York Mellon in London.
The prime minister followed King's lead yesterday: "Having taken action on the banking system, we must now take action on the global financial recession which is likely to cause recession in America, France, Italy, Germany, Japan and - because no country can insulate itself from it - Britain too," Gordon Brown told the Commons.
Economists at the Swiss investment bank UBS forecast yesterday that Britain would suffer the deepest recession of any major economy, with its economy contracting by 1.4% next year, as the effects of the financial crisis are compounded by a "collapsing" housing market. They also predicted recession in the eurozone and the United States.
The gloomy tone of King's words was continued in minutes released yesterday of the monetary policy committee meeting on October 8 which showed members voted unanimously in favour of the unprecedented, emergency half-point interest rate cut as the financial system teetered on the brink of collapse.
King and the other eight committee members all agreed that half a percentage point should be lopped off rates as part of a coordinated cut by central banks around the world, including the US Federal Reserve and the European Central Bank. The cut took UK rates down to 4.5%.
The MPC minutes said: "Given the global nature of the financial market turbulence, there was a strong argument for participating in the proposed coordinated international action."
Analysts believe that more cuts will be made next month, with some predicting that rates will be slashed to 2% by next year.
Philip Shaw at Investec said: "It's not at all surprising that the vote to cut rates by 50 basis points was unanimous. The committee is talking about the evidence being clearly sufficient to justify a half point which hints that another fall in rates seems likely in November - particularly given the continued run of bad economic news."
Britain was not the only country facing a sharp decline in its currency. The Hungarian authorities jacked up interest rates by three percentage points yesterday, taking them to 11.5%, as it tried to prevent a big slide in the value of the forint, which has tumbled 16% against the euro since the summer. "The financial crisis is now moving from the west to the east," said Andrew Milligan, economist at Standard Life Investments.
At a glance

Pros
Rebalancing of economy: exports will be cheaper and imports pricier - helping narrow Britain's huge trade gap
Companies: earn more abroad
Cons
Holidays abroad: shopping trips to the US more pricey; travel firms may levy a surcharge
Fuel: oil priced in dollars so people and businesses in the UK will not feel the full benefit of its recent fall
Shopping: imports pricier - bad for Christmas shoppers and retail sector

• Recession
• Economics
• Currencies

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[Legal Beagles]

Viewpoint: Pound can expect to slump lower against US dollar


How low could the pound go? The short answer is: quite a bit lower against the US dollar; maybe not much further against the euro.
Sterling has been a screaming sell against the dollar since the summer, when it was defying gravity by trading close to $2.00. That was close to the top of a 25-year range, even though forecasts for growth in the UK were being slashed more aggressively than for any other G7 economy.
It took Mervyn King's warnings about recession on Tuesday night to provoke yesterday's big sell-off, but there is no reason to believe that support will emerge at the new rate of $1.63 or so. First, sterling still stands a few cents above most economists' estimates of where purchasing power parity lies - somewhere between $1.50 and $1.60 is the usual rule of thumb.
Second, buying dollars is once again a safe option for corporate treasurers and international investors. Troubles in eastern Europe are undermining the euro - cuts in interest rates in the eurozone could eventually be as deep as in the UK. Money managers increasingly feel they know what they're getting from the US Federal Reserve, which has already cut rates to 1.5%.
Third, the idea is gaining ground that the US, being the first into the downturn, will be first out. Given the massive trade imbalances in the US and the level of personal debt, that script takes some believing. But in the foreign exchange game everything is relative - buying one currency implies selling another - and there's no denying that the US's relative position has improved as the rest of the world's, including Asia's, has deteriorated.
Fourth, King sounds as if he wants sterling to fall. At the end of his speech, he highlighted how reliant British banks had become in recent years on flows of capital from overseas. If other forms of external finance don't fill the gap, adjustments in the trade deficit and exchange rate "will need to be larger and faster than would otherwise have occurred", he concluded.
We certainly saw a fast adjustment yesterday. Is it large enough? Probably not, for the simple reason that we have yet to see many of the beneficial effects of a falling currency, such as a boost to exports.
The manufacturing sector has been contracting for a couple of quarters. When that position starts to turn around, it will be time to start thinking about sterling stabilising against the dollar.
The position against the euro, though, looks very different. The German finance minister, Peer Steinbrück, was trying to maintain as recently as last month that the credit crunch was a US phenomenon. The same thinking infected the European Central Bank, which actually raised interest rates once this year to combat inflation. The reality of recession has dawned late in the eurozone. Now its bankers and finance ministers face the difficult job of fighting a downturn without fiscal union. They will soon be sounding as gloomy as King and Gordon Brown.
No puff from Duddy
A falling currency is not much help to importers, however, as Terry Duddy, chief executive of Home Retail Group, pointed out. General merchandisers, such as his Argos and Homebase chains, buy half their goods from the far east. A combination of rising costs and weakening demand at home is vicious. Duddy calls the outlook "depressing".
The research group Verdict goes further, predicting the "toughest trading environment ever" this Christmas. It is surely guilty of hyperbole - there were some pretty bleak Christmases as recently as the 1980s - but we get the picture.
Indeed, the most telling news is that retailers as diverse as Sainsbury's and Debenhams are already reporting that sales of Christmas-related goods - everything from Christmas puddings to perfume - are well above normal levels because shoppers are trying to spread out the cost of Christmas by buying early.
Yet this factor is impossible to detect in current sales numbers. Like-for-like sales at Argos, which relies heavily on pre-Christmas trading, are running 9% below last year's levels. So underlying demand on the high street may be even worse than recent snapshots suggest.
Has the stockmarket priced in all this pessimism? Frankly, you doubt it. There has been plenty of talk about buying bombed-out consumer stocks for their recovery potential. It looks premature. Duddy said that 2009 is "likely to be at least as challenging as 2008". The big increases in unemployment are yet to come. And lower interest rates take months to filter into shoppers' purses.
Retailers need some old-fashioned wage inflation. As yet, there's no sign of it. The retail sector still looks to be a sell.
nils.pratley@guardian.co.uk

• Currencies

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