The dramatic level of volatility surrounding the Pound continued yesterday as the UK currency slumped against the majority of the majors, despite a pickup in global stocks, as UK service sector growth contracted at the fastest pace in at least 12-years and consumer confidence deteriorated.

The Pound plunged towards a fresh record low at 1.1631 versus the Euro, while the UK currency also traded under $1.4700 against the Dollar, dropping 1.7% on the session and extending its yearly loss to 26%, the most since records began in 1972.

An index based on a survey of UK service companies slumped to a reading of 40.1, the lowest level since records began in 1996, while a survey from the Nationwide Building Society showed that a gauge of consumer sentiment sank to the lowest level since at least 2004.

Earlier this week UK manufacturing and construction surveys also showed the fastest pace of contraction on record in November, signalling that the UK recession has deepened and raised the probability of an aggressive easing in interest rates this lunchtime.

The sharp contraction in UK economic growth is showing few signs of slowing and there is a very real risk that the Bank of England will cut interest rates to zero per cent over the coming months and policy makers will probably slash the benchmark lending rate by one percentage point this month, bringing interest rates to the lowest level since 1951.

The report yesterday from the Chartered Institute of Purchasing and Supply showed that an index of service industries, which make up roughly three quarters of the economy compared with about 20% for manufacturing and construction, actually declined by more than initial forecasts to suggest the slump is worsening.

As a result, Investec altered its forecast after the release of the services data to predict a 1% cut instead of only a 50 basis point reduction from the current 3%, and the Pound subsequently declined against all 16 of the most actively traded currencies.

The tone of yesterday’s reports were met with cynicism by the market and there are big expectations for today’s Bank of England rate announcement as investors will be disappointed if it’s anything less than 100 basis points and it will be compelling to see the Pound’s reaction to such a decision.

Elsewhere, the record drop in the Nationwide consumer confidence index coincided with reports that the Royal Bank of Scotland Plc scrapped its full year profit forecast as credit losses escalated and bad loans rose.

Shareholders have conceded control of the Bank to the UK government as part of plans to shore up the banking system and the Prime Minister’s main objective now is to do whatever is necessary to spur lending and boost spending.

In addition, Gordon Brown said that the UK government will guarantee interest payments worth up to £1 billion owed by homeowners, who are struggling to keep up with mortgages, in an effort to prevent home repossessions and mounting mortgage defaults.

The UK treasury will guarantee payments to banks and allow homeowners who normally would have been refused a ‘payment holiday’ to a defer a proportion of their payments by up to two years and according to the Prime Minister, eight of the largest UK mortgage lenders have signed up to the plan.

The measure is the latest government initiative to cushion the economy from the recession following the largest fiscal stimulus package announced in November where Alistair Darling lowered VAT by 2.5 percentage points and increased the highest tax rate to 45%.

The chart attached shows the correlation between the drop in UK stocks and the decline in Sterling but yesterday the FTSE 100 index rallied for a second consecutive day after the dismal UK fundamentals bolstered speculation that the Bank of England will cut rates aggressively and revive the ailing economy.

The Euro is gathering momentum against the Pound and the single currency also made further gains versus the Dollar as we build up to the ECB interest rate announcement and accompanying press conference.

The European Central Bank are expected to slash borrowing costs by a further 50 basis points this month and it will be interesting to analyse Trichet’s comments in the press conference for clues on the probability of a further reduction in January as policy makers attempt to revive growth and boost lending.

The recent positive sentiment surrounding the Euro continued yesterday despite reports that European services also contracted at a record pace in November, while retail sales fell more than forecast and increased pressure on the ECB to suspend gradual monetary easing and cut dramatically in line with other central banks.

Data Released 4th November

U.K 12:00 BoE Rate Announcement

EU 10:00 Gross Domestic Product (Q3 Revised)

EU 12:45 ECB Interest Rate Announcement

EU 13:30 ECB Press Conference & Forecasts

U.S 13:30 Initial Jobless Claims (w/e 28th November)

U.S 15:00 Factory Order (October)

written by Adam Solomon