The Pound relinquished earlier gains against the Dollar yesterday as the turmoil sweeping through financial markets forced the Bank of England to respond with measures to provide some short-term liquidity to the market and inject an additional £5 billion in emergency funding.

The UK currency had earlier risen to a high of $1.8127 versus the Dollar following reports that Lehman Brothers Holdings Inc, the fourth largest U.S investment bank, filed for the biggest bankruptcy in history while Merrill Lynch & Co agreed to be bailed out by Bank of America after the year-long credit crunch cost banks in excess of $515 billion.

Lehman Brothers have survived the railroad bankruptcies of the 1800s, the Great Depression that followed the Wall Street Crash in 1929 and the collapse of long term capital management but the 158-year old firm has succumbed to the collapse of the U.S subprime mortgage market.

UK stocks slumped by the most in eight months yesterday as share prices in financial companies tumbled while HBOS Plc, the UK’s biggest mortgage lender, dropping a record 27% on the session and Barclays Plc and the Royal Bank of Scotland Plc both dipped 13%, to record the steepest losses since records began in 1988.

Elsewhere, the Pound was also undermined after the Confederation of British Industry said that the Bank of England should lower interest rates aggressively in November to halt for the first recession since the early 1990s.

A number of key industries have fallen into negative growth as manufacturing output slumped in August and the CBI acknowledged that companies are having a “tough time” in the current economic climate.

The director of the CBI also told reporters that policy makers should consider a “half-point cut in November”, assuming that the inflation outlook doesn’t change as commodity prices continue to fall to the lowest level in six months.

The Bank of England have so far been reluctant to lower borrowing costs amid the fastest pace of inflation in at least a decade but the EU have recently said that the UK economy has already entered its first recession since 1991 and policy makers may be forced into action and provide some relief to the market.

In terms of economic data, the focus this morning will fall on the latest consumer price index and the report is expected to confirm that inflationary pressures increased a further 0.6% on the month in August with the annual rate rising to 4.6% from this stage in 2007.

The 30% drop in oil prices has yet to feed through to the broader economy and the outcome of the report will provide a difficult dilemma for the Bank’s Monetary Policy Committee as rising prices become embedded in the economy and weigh on consumer confidence.

The Euro has declined 10% against the Dollar since touching a record high in July and EU officials admitted yesterday that the correction is a welcome relief as the Euro-zone economy teeters on the brink of a recession.

The excessive volatility saturating the market is “undesirable for economic growth” according to the accompanying statement and the ECB will remain defiant in their quest for price stability, which may support the Euro in the short-term amid speculation of a U.S interest rate cut.

The Dollar declined against the majority of the 16 most actively traded currencies yesterday while the Australian and New Zealand Dollar struggled to stem the tide as an element of risk aversion dominated the market and traders sold higher yielding currencies in favour of cheaper loans from Japan.

The financial implications of yesterday’s news and the subsequent volatility that spread through the market in the aftermath of the announcement seems to indicate that the credit market turmoil is deepening and that may force the Federal Reserve to slash interest rates this evening.

Data Released 16th August

U.K 09:30 DCLG House Prices (August)

U.K 09:30 Consumer Price Index (August)

- Retail Price Index

GER 10:00 ZEW Index (September)

EU 10:00 HICP (August Final)

- Harmonised Index of Consumer Prices

U.S 13:30 Consumer Price Index (August)

- Ex Food & Energy

U.S 13:30 Real Earnings (August)

U.S 14:00 TICS Capital Inflows (July)

U.S 18:00 NAHB Housing Index (September)

U.S 19:15 FOMC Rate Decision

written by Adam Solomon