Currencies

THE British pound is expected to trade little changed this week, steeled against further losses after Thursday's bigger than expected interest rate cut brightened the outlook for UK economic growth.

"The Bank of England has bitten the bullet," said Helena Morrissey, fixed- income manager at Newton Investment Management. "It's what the economy needs" and should keep the pound trading above Thursday's low of DM2.7436, she said.

The pound rose on Friday to DM2.7626, erasing the decline to DM2.7436 on Thursday from DM2.7600 before the noon rate announcement. It was unchanged against the dollar at $1.6625.

While lower rates generally hurt a currency - and, indeed, recently sent the pound to a 16-month low against the mark and to a two-month low against the dollar - analysts interpreted the Bank of England's relatively aggressive, half-point rate reduction as beneficial for the currency.

"The central bank has shown it's going to do all it can to avoid a recession, and in the longer term, a stronger economy is good news for the pound," said Kirit Shah, market strategist at Sanwa International.

The Bank of England, trying to avert recession, last week cut rates for the second time in less than a month. It lowered the country's benchmark lending rate to 6.75 per cent from 7.25 per cent, while most economists expected a quarter-point reduction.

Even after the rate cuts, UK rates are higher than those in the US and Germany, giving the pound an attractive money-market return. Three-month sterling deposits yield 7.06 per cent, while dollar deposits bring 5.38 per cent and mark deposits 3.60 per cent.

Evidence of slowing UK growth is piling up. Last week reports showed that manufacturing output declined 0.4 per cent in September from August. An 18 per cent trade-weighted gain in the pound since August 1996 makes UK goods more expensive overseas. The CBI said retail sales growth slowed to the weakest in three years in the last three months.

Thursday's rate cut may be enough protect growth, at least for this year. Most economists now expect the bank to leave rates unchanged after its next Monetary Policy Committee meeting on 9 and 10 December, with a minority predicting another quarter-point cut.

"The fact that we've had a 50 basis-point cut makes it slightly less likely [rates will fall again in December]", said Philip Williams, a director at Chiswell Associates. "A lot will depend on the data flow and on the surveys, which they seem to be tuned to."

On Monday, a report on producer prices is expected to show that output prices fell 0.1 per cent in October, the same as in September. Analysts also forecast the unemployment rate, to be released on Wednesday, was unchanged at an annual 4.6 per cent in October from September.

"The economy is slowing to a crawl and, even now, base rates are too high and still threaten a recession," said David Brickman, an international economist at PaineWebber International. "Further large cuts in interest rates are coming, and we look for at least another 1 percentage point off base rates in the next six months."

Mr Williams agreed. "The trough in interest rates in this cycle will be 5 per cent and quite possibly lower," he said, adding that sterling will weaken to below DM2.65 within the next 12 months. Copyright: IOS & Bloomberg