Pound Plunges To New Record Low Against Euro As UK Economy Contracts For First Time Since 1992

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Friday, the pound slumped to a new record low against the euro after a report showed that the UK economy contracted for the first time since 1992 in the third quarter. The third quarter GDP also dropped more than economists expected. The pound also slumped to a 6-year low against the dollar and a 13-year low against the yen and the franc.

A preliminary estimate from the Office for National Statistics, or ONS showed that the UK economy contracted 0.5% in the third quarter from the prior quarter compared with zero growth in the second quarter. This was the first contraction since 1992. The ONS said "It has been 64 periods since the last period of negative growth in 1992 Q2." Economists had expected just 0.2% sequential fall in the third quarter.

The economy expanded 0.3% year-on-year in the third quarter, much slower than a 1.5% rise seen in the second quarter. The annual growth rate also stood below the expected 0.5%.

The pound was under heavy pressure after the Bank of England Governor Mervyn King said on Tuesday that the UK economy probably faces a recession and policy makers will act to prevent inflation from slowing too far after the country's worst banking crisis since World War I.

House prices will extend declines and the pound may depreciate further, King said, in his first explicit acknowledgement that the U.K. may be heading into a recession.

Although the financial crisis is global, sterling is at the centre of the storm as its economy is perceived as more vulnerable than most advanced economies.

The U.K. is already in a recession and the economy will contract for the next three quarters, Ernst & Young's ITEM Club, which uses the same forecasting model as the Treasury, said in a report on October 20.

A collapse in the credit markets and the worst housing market in a generation are driving the U.K. economy, Europe's second- biggest, toward a slump. Expectations for rate cuts in Europe and the U.K. are growing stronger day-by-day because of the weak economic outlook.

Today's GDP report increased speculation that the Bank of England may cut interest rates in the near future. The Monetary Policy Committee slashed its benchmark rate by 50 basis points to 4.50% earlier this month.

The minutes of the Bank of England's rate setting session showed that the members voted unanimously to cut the bank rate on October 8. In the special meeting, the Monetary Policy Committee decided to reduce the bank rate by 50 basis points to 4.5%. In a coordinated move, the Bank of Canada, the European Central Bank, the US Federal Reserve, Sveriges Riksbank and the Swiss National Bank slashed their key interest rate.

"Given the global nature of the financial market turbulence, there was a strong argument for participating in the proposed coordinated international action," the minutes stated.

The committee judged that, during the last month, the balance of risks to inflation in the medium term had shifted decisively to the downside. The MPC noted that pay growth had remained subdued and commodity price pressures had eased, with oil prices falling substantially from their mid-summer peak.

During early deals on Friday, the pound slumped to a new record low of 0.8199 against the euro, surpassing its previous level 0.8189 hit in early September. The euro-pound pair was worth 0.7972 at yesterday's close. The pound has lost 6% against the euro since reaching a 7-month peak of 0.7697 on October 20.

In economic news from Europe, the results of the consumer confidence survey conducted by the economic think tank ISAE showed that the sentiment indicator declined to 102.2 in October from 102.8 in September. Economists had expected the indicator to log a reading of 100.

Germany's Federal Statistical Office announced that import prices increased 7.6% year-over-year in September, smaller than the 9.3% increase recorded in the previous month. Economists expected an increase of 7.8%. On a monthly basis, import prices declined 1% in September, after falling 0.8% in August. Economists were looking a decrease of 0.9%

The pound, which closed yesterday's trading at 158.79 against the yen dropped to a 13-year low of 139.09 in early deals on Friday. If the pound-yen pair slides further, it is likely to target the 130.2 level.

The yen soared as the global stock market sell-off triggered large scale unwinding of carry trade position. In carry trade, investors borrow money from Japan where the interest rate is low to buy high yielding assets in other countries. So, an unwinding of carry trades results in traders liquidating their investments and scrambling for yen to repay their yen-denominated loans, which pushes up the value of the Japanese currency.

Tokyo stocks plunged today with investor sentiment hurt by persistent fears about a global recession, sending the key Nikkei index below the 8,000 line for the first time since May 2003, amid a wave of panic selling as investors became increasingly pessimistic about Japanese corporate earnings following Sony Corp.'s sharp downward revision of its financial outlook.

The 225-issue Nikkei Stock Average lost 811.90 points, or 9.60 percent, from Thursday to 7,649.08, marking the first time the Nikkei closed below the 8,000 mark since May 2, 2003, at 7,907.19. The Nikkei's closing quote was the lowest since April 28, 2003, when it finished at 7,607.88. The broader Topix index of all First Section issues on the Tokyo Stock Exchange was down 65.59 points, or 7.52 percent, to 806.11.

In early trading on Friday, the pound slipped to 1.5268 against the dollar. This set a 6-year low for the UK currency. On the downside, 1.50 is seen as the next target for the pound. The pound-dollar pair closed yesterday's North American session at 1.6269.

The dollar spiked higher as the oil prices fell below $64 a barrel today, as gloom about a global economic downturn took the steam out of an OPEC agreement to cut output by 1.5 million barrels a day. Ministers of the Organization of the Petroleum Exporting Countries agreed at an emergency meeting in Vienna to take 1.5 million bpd off the market.

Against the Swiss franc, the British currency fell to a 13-year low of 1.7599 during early deals on Friday. This may be compared to yesterday's closing value of 1.8843. The next downside target level for the pound-franc pair is seen at 1.743.

Markets now look forward to the North American session, in which the US existing home sales report for September has been slated for release.

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