Following on from last week, recent negative rhetoric from the Bank of England undermined confidence in the Pound to the degree where Sterling fell to the lowest level on record against the Euro and sank to 6-year low versus the Dollar.

The UK currency suffered its biggest weekly decline against its European counterpart since common currency’s debut in 1999, consolidating just above 1.1600 on Friday, amid mounting evidence that the UK economy is in the grip of the worst recession since the end of the second World War.

The catalyst for the Pound’s monumental decline came on Wednesday as Mervyn King, the governor of the Bank of England, appeared reluctant to rule out the possibility of cutting interest rates to zero per cent, while the rising unemployment rate will make it harder for the UK to spend its way out of a recession.

The Pound also lost an unprecedented 5.1% in value against the Dollar to trade under $1.4600 on Friday and investors will continue selling the Pound until it reaches the major support at $1.4000 as the weakness in the UK economy and falling inflationary concerns gives policy makers the premise to reduce rates further.

According to recent estimates from the Bank of England, the UK economy will contract by an annual 1.8% in the first three months of 2009, while inflation will slow and breach below the government’s 2.0% target as traders continue to drive the price of oil towards $30 a barrel.

In a sense, King’s comments last week were a veiled endorsement for the Pound’s decline to act as a way to revive the struggling economy, while MPC member Andrew Sentence said that the Pound’s slide against the majors will make it easier for manufacturers to cope with a recession.

The Pound’s recent performance against the Euro suggests that the market doesn’t think the European Central Bank will cut interest rates as aggressively as the Bank of England and with UK fundamentals continuing to deteriorate, Sterling weakness is likely to persist over the coming weeks.

In the wake of King’s comments and the subsequent reaction in the market, the Prime Minister Gordon Brown urged the opposition to be "responsible" in commenting on the Pound after an interview with George Osborne in the Time newspaper.

At the G-20 summit in Washington, Brown told reporters that it would not be sensible for him to comment on exchange rates after Osborne, who is responsible for the Conservatives’ economic policy, warned that the government runs the risk of triggering a "collapse" in the Pound.

His comments are the first from a senior UK politician to raise the spectre of a currency crisis that is becoming comparable to those suffered by Britain in 1970s and early 1990s or to indicate that the Pound may suffer a similar fate to that of the Icelandic currency
following the collapse of its banking system.

The Pound has lost more than a quarter of its value in just four months, declining from $2.00 in July to less than $1.50 last and the UK currency has dropped 20% against the Euro in the past month, a trend similar to the Pound’s performance versus the Deutsche Mark in September 1992.

In terms of UK economic data, the focus this week will fall on the headline consumer price index on Tuesday and the report is forecast to show a sharp decline from September’s 5.2%, further easing concerns about the upside inflation risks.

In addition, financial markets will also be paying particular attention to Wednesday’s minutes from the Bank of England’s November policy meeting where the MPC slashed interest rates by 1.5%, the single biggest move in 27-years.

The tone and language used in the report as well as the voting pattern should provide further insights into how low the Central Bank are prepared to cut interest rates and the Pound will probably come under further selling pressure in the build up to the report.

The Euro’s momentum against the Pound is showing few signs of slowing despite European stocks retreating for a second successive week as the German economy sank deeper into a recession than initially forecast, the U.S scrapped plans to buy mortgage assets from banks and the declining oil price sent energy shares tumbling.

The European economy is sinking further into its first recession since the introduction of the Euro in 1999 and a number of financial institutions including Deutsche Bank AG and Citigroup Inc say that growth will fall further into negative territory and won’t return until late 2009.

The downturn in sentiment leaves policy makers scrambling to limit the depth of the recession and the ECB is poised to cut interest rates again next month, while other governments are lining up fiscal stimulus problems, their efforts may come too late for the recovery from lagging behind that of the U.S.

The Federal Reserve’s proactive response to the global credit crisis means that the U.S is currently well ahead of the curve compared to Europe and the UK and that is reflected in Dollar’s overwhelming appreciation in the market.

Data Released 17th November

EU 10:00 Foreign Trade Balance (September)

U.S 13:30 Empire State Index (November)

U.S 14:15 Industrial Production (October)

- Capacity Utilisation

written by Adam Solomon