The pound yesterday made its biggest rise against the euro since the introduction of the single currency a decade ago.
It follows speculation the European Central Bank (ECB) may cut interest rates from 2.5% to limit the fallout from the recession.
ECB vice president Lucas Papademos has said that further rate cuts may be needed should inflation keep slowing.
The pound also gained against the dollar on speculation the Government may guarantee asset-backed securities to encourage banks to lend, said Hans-Guenter Redeker at BNP Paribas SA in London.
“Europe is going to provide a lot of negative news going forward,” said Redeker, global head of foreign-exchange strategy at BNP Paribas. There “has been talk of this government discussion concerning providing a guarantee for asset-backed securities” and this was positive for sterling, he said.
The pound rose as much as 3.4% to 92.51 pence per euro, strengthening to less than 93 pence for the first time since December 22. The pound traded at 92.80 pence last night from 95.69 on Friday.
It also gained 0.5% to $1.4615, rebounding from a drop of as much as 0.8%. The euro-area economy is likely to “remain weak” this year and may even contract in the first half, Papademos said yesterday in a speech in San Francisco. While inflation could “drop considerably” around the middle of the year, the risk of deflation is “nil,” he said.
Bank of England Governor Mervyn King may follow the Federal Reserve and pursue other ways of pumping money into the British economy, such as expanding the £200bn programme that allows banks to swap illiquid securities for government debt, economists said.
The pound slid 23% against the currency last year, its biggest decline since the euro came into existence in 1999, as the Bank of England cut rates faster than the ECB and the British economy prepared to enter its first recession in 17 years. Policy makers will probably cut the benchmark interest rate to 1.5 % from 2% on Thursday, the lowest level in the bank’s three-century history, according to economists. It is also anticipated that the ECB will cut rates to 1.50% by the end of the second quarter, from 2.5% when it meets on January 15.
“Euro-sterling could see a significant decline,” said Redeker, who predicts the pound strengthening to 90 pence per euro by the end of March and to 84 pence by year-end. The euro is poised to decline by 10% versus a basket of currencies including the pound, the Norwegian krone and the Swedish krona, Goldman Sachs Group Inc. said. “Forced euro buying is likely to abate as tension in credit markets becomes less severe,” currency strategists led by Jens Nordvig, New York-based senior global market economist at Goldman Sachs, wrote in a note yesterday.
“Investor flows in part driven by attractive valuations are likely to pick up as risk taking picks up from very depressed levels” in the fourth quarter of 2008, according to the report.