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The pound was sent into a tailspin against the euro yesterday after the Bank of England revealed that it considered cutting interest rates by more than the full percentage point announced by its monetary policy committee (MPC) this month.
In a fresh day of turbulence on the foreign exchanges, sterling joined the dollar in falling sharply against the European single currency and ended the day at a record low of €1.0769.
Foreign exchange dealers saw the minutes of the December MPC meeting as a clear signal that Threadneedle Street would cut the cost of borrowing again at its next meeting. Rates have been slashed from 5% to 2% since early October in response to the economy's descent into recession and are already at their lowest level in the Bank's 314-year history.
This month's MPC meeting cut rates by a percentage point but discussed "whether a larger cut was warranted" in view of the risks that inflation might fall too sharply as the economy slows. But although the MPC sounded an alarm at the freezing-up of bank lending, it concluded that a rate reduction that surprised the City might lead to an "excessive fall" in the pound and "could undermine confidence in the economy more widely".
Despite the MPC's concerns, the prospect of further reductions in the bank rate saw the pound lose more than three cents against the euro, closing in rapidly on parity. Travellers going abroad are already finding that they are receiving less than one euro to the pound.
Analysts said that the Bank of England had not been forceful in its support for sterling, appearing to welcome the boost to exports that this autumn's depreciation of the currency would provide at a time of weak domestic demand.
Phil Shaw, economist at Investec, said: "It is very clear that the MPC judges that the stance of policy is too tight given current economic prospects.
"Accordingly, a further easing in rates is odds on next month and we still see a half-point cut in the bank rate to 1.5%. A deeper reduction cannot be ruled out, but an argument against this is that the committee might want to save some of its firepower for later."
Sterling's weakness was a minor part of the action on the foreign exchanges yesterday, with attention mainly focused on the falling dollar after the Federal Reserve's announcement on Tuesday that it was cutting short-term interest rates virtually to zero and contemplating a range of emergency measures to boost the US economy.
The dollar dropped to a 13-year-low against the Japanese yen at just over ¥87 and dropped to below $1.44 against the euro - a drop of 13% in a month.
Analysts said the similarities between Britain and the US explained why both currencies were under pressure on the foreign exchanges. "Sterling is facing the same problem as the United States ... the UK economy is very specialised and dependent on the financial sector," said David Woo, head of FX Strategy at Barclays Capital in London. "Although we think sterling is undervalued, it's hard to be bullish."
Nick Fullerton, managing director of the foreign currency specialists FC Exchange, said: "While the interest rate cut has eased the pressure on consumers, it has hammered sterling, which initially fell to 1.13 against the euro.
"The minutes from the meeting show that the MPC was trying to put a protective barrier around sterling by not slashing rates even more. This news has done no favours to an ailing pound, which has now fallen to 1.07 territory and we are expecting to see it go into a tailspin against other currencies, although not the US dollar."
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