Sterling slumps to weakest level against dollar in seven years

Disappointed manufacturers exporting to the Continent are left wistfully watching the euro

The pound tumbled against the dollar yesterday, falling below $1.45 for the first time since 1993.

The pound tumbled against the dollar yesterday, falling below $1.45 for the first time since 1993.

The pound has now lost 10 per cent against the dollar since the start of the year on growing expectations that interest rates in the UK will not keep pace with the US and may even have peaked.

But the euro was left out of the party. Sterling did weaken slightly, falling to a one-month low, but there was little sign the markets had changed their minds about the beleaguered single currency. The euro fell to a record low against the Japanese currency of 94.10 yen despite forecasts that the European Central Bank will raise rates today.

"The underlying reason behind the move is still the same - the interest rate outlook," said Audrey Childe-Freeman, European economist at CIBC World Markets in London.

There is a growing acceptance that UK rates look set to stay below those in the US. In May the Federal Reserve hiked rates to 6.5 per cent while the Bank of England has stayed pat at 6 per cent since February. This is the first time since 1983 borrowing costs have been higher in America than Britain.

The Confederation of British Industry, which has long complained that the strength of sterling is harming the long-term future of manufacturing, gave a lukewarm reception. "In one sense it is the wrong currency to be falling against because it is not the one that gives the most competitive difficulties," said Kate Barker, the CBI's chief economist. While half of UK trade is with euro-denominated countries, just 15 per cent is with the US.

Ms Barker added: "There is a worry when you see the pound falling against the dollar because of the issue of commodities such as oil being priced in dollars."

But she did not believe the fall was enough to force the Bank to raise rates to combat inflationary pressure. Other economists agreed, saying it was unlikely the Bank's Monetary Policy Committee would react with a knee-jerk hike. David Bloom, a global economist at HSBC in London, said there had been a "sea change" in the perception of sterling in the wake of the Bank's August Inflation Report.

"Previous to the last report, the thinking was that every time sterling fell, this was seen as inflationary. Therefore the expectation was for the MPC to raise rates and this pushed sterling back up," he said.

But the August report showed inflation overshooting the Government's target - for the first time in the three years of Bank independence - without any sign the MPC was poised to order an immediate rate rise.

"They are prepared to countenance a lower pound for higher inflation. The pound has fallen but the interest rate markets have not started to expect higher interest rates," Mr Bloom said. "So there has been a sea change. They have attempted to massage the currency down and it has worked."

Some of the main beneficiaries of the pound's fall against the dollar will be multinationals that operate in the US, such as Vodafone, GlaxoWellcome and SmithKline Beecham. They will find already sizeable US profits translate into a higher sterling value in their balance sheets.

Adrian Coats, group treasurer at ScottishPower, the electricity, gas, water and telecoms supplier which has a large US subsidiary, said: "A strong dollar is good for us. It translates into more sterling per dollar."

Ironically, this would broaden a divide within the manufacturing sector between hi-techs such as mobile phone and drugs companies, which are enjoying strong growth, and traditional sectors which are contracting. "It depends what industry you are in," said Stephen Radley, chief economist at the Engineering Employers' Federation. "We have not heard any cheering from the rafters so far."

Mr Bloom said: "What you will get is an extremely positive translation effect when what in fact you want is a transaction effect - increasing exports."

The CBI's Ms Barker said sterling's fall against the dollar could indicate a favourable trend. She said it could be a sign the pound was detaching from the dollar and moving towards the euro - showing the markets realised the UK economy had more in common with the eurozone than the US. "Logically we would expect that to happen and that should mean sterling falling against the euro, which would be helpful."

The problem, according to Mr Bloom, is that there is no sign of that. "If you turn negative on sterling you will buy an asset you want. It is difficult to see any reason to buy the euro, so the pressure is against the dollar."

The danger, therefore, is that the volatility businesses have suffered on the euro exchange rate will now be repeated with the dollar. "We have already seen a greater volatility than we have seen in the recent past," said Ms Barker. ScottishPower's Mr Coats added: "Sterling has been steady in recent years. When we were between $1.50 and $1.75 we could be more relaxed about it. Although I don't think it can harm us, but volatility can be unsettling."

David Brickman, UK economist at PaineWebber International, cautioned against assuming a re-rating between sterling and the dollar. "This optimism may prove misplaced in the medium term," he said.

Although inflation in both house prices and wages had weakened, the labour market was still tight and the economy was growing above trend.

"The MPC is still seen hiking rates to 6.5 per cent over the next six months," he said, adding that PaineWebber expected enough of a US slowdown to block any further rate hikes. "Against this backdrop, sterling looks cheap against the US."