The Pound rose higher against the Euro yesterday, touching a high of 1.2492, after the Bank of England cut UK interest rates by a much greater-than-forecast 1.5% to bring the benchmark lending rate to the lowest level since 1955 and fuelled optimism that the faltering economy will recover faster than expected.

In the aftermath of the announcement, UK stocks plunged and government bonds gained as the Central Bank’s monetary policy committee, led by the governor Mervyn King, slashed rates to just 3.0% despite preliminary forecasts of a more reserved 50 basis point reduction.

The subsequent positive momentum surrounding the Pound is hardly surprising since financial markets are now looking to reward proactive central banks and the move may trigger a prolonged period of upside Sterling momentum against the Euro, particularly in an environment dominated by risk aversion.

Prior to yesterday’s dramatic easing of rates, the UK economy had the highest interest rate in the Group of Seven industrialised nations but a 150 basis point reduction means that the Pound is now considered a lower yielding currency and therefore lower risk than the Euro.

Recent estimates from the European Commission suggests that the struggling UK economy may contract 1% in 2009, while falling a further 0.5% in October alone to signal the first recession since the early 1990s, while the vulnerability in the global banking system meant that policy makers had to act aggressively.

Nevertheless, the Bank’s decision to lower borrowing costs to 3.0% means that the economy is likely to recover quicker and policy makers are hoping that banks will pass on the reduction in rates to the consumer and revive the UK property market as house prices have fallen 13.7% in the last quarter from just a year earlier.

The extent of the reduction was the biggest one step rate cut since September 18th 1992 and the aftermath of Britain’s ejection from Europe’s exchange rate mechanism that was the precursor to the Euro.

The Pound extended its advance against the single currency after the European Central Bank also lowered interest rates in the midday announcement but the market was seemingly disappointed that policy makers only cut rates by the anticipated 50 basis points.

Global policy makers are escalating their response to the worldwide credit crisis after a cohesive round of rate cuts in October but the ECB’s reluctance to lower its main refinancing rate from the current 3.25% saw the Euro decline against the majority of the major currencies.

In the accompanying statement, the Euro continued to decline against the Dollar, Yen and Pound as the ECB chairman Jean-Claude Trichet said that the European economy “weakened significantly” in the last quarter and the IMF cut growth forecasts in the region.

The single currency slumped to a two week low versus the Dollar as Trichet also said that more reductions are likely to follow and today’s price action seems to indicate that the U.S Federal Reserve is ahead of the curve in monetary easing after slashing interest rates by 325 basis points over the past year.

The Euro declined 1.7% to $1.2740 in the afternoon session, having weakened 20% since climbing to a record high in July but Trichet also confirmed that the ECB’s governing council members discussed a 75 basis point reduction before agreeing that 50 basis points would be sufficient in October.

Policy makers have been reluctant to lower interest rates this year as the annual pace of inflation rose to more than double the Central Bank’s target but Trichet acknowledged yesterday that “in such an environment, price, cost and wage pressures should moderate.”

In the latest numbers, inflation in the Euro-region slowed to 3.2% in October after reaching a 16-year high of 4.0% in July as oil prices have halved from an all time record high of $147 a barrel in July.

In aftermath of Trichet’s comments, economists predict that the ECB will cut borrowing costs at the most aggressive pace in its 10-year history and reduce rates to 2.5% by April 2009 as the economy sinks further into a recession.

The Dollar was largely to reactive to events overseas yesterday but the feel good factor from Barack Obama’s historic victory in the U.S Presidential election was short-lived as U.S stocks and commodities continued to plummet.

In terms of economic data, the Dollar remained largely unmoved as U.S non-farm productivity growth slumped for the third consecutive quarter, while a separate report from the Labour Department showed that U.S jobless claims hit a 25-year high.

The focus today will inevitably fall on the monthly U.S employment report and considering the sharp rise in the jobless rate over the past month, non-farm payrolls are expected to decline by 185,000 with the unemployment rate rising to 6.3%.

Data Released 7th November

GER 11:00 Industrial Production (September)

U.S 13:30 Non-Farm Payrolls (October)
- Unemployment Rate

- Average Earnings

U.S 15:00 Pending Home Sales (September)

U.S 15:00 Wholesale Inventories (September)

U.S 20:00 Consumer Credit (September)

written by Adam Solomon