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FOCUS: How Much Lower Can Sterling Slide?

By Rebecca Bundhun

Of DOW JONES NEWSWIRES

LONDON -(Dow Jones)- The pound has suffered its sharpest monthly fall against the dollar since Black Wednesday in 1992, with strategists debating how deep the slide will go.

The pound's dramatic 8% fall since the end of July has been fueled by a crash in the housing market and growing recession risk facing the U.K. economy. Both have given rise to speculation that there could be a cut in Bank of England interest rates before the year's end.

A monthly drop of such magnitude hasn't been seen since October 1992, after the British government was forced to withdraw the pound from the European Exchange-Rate Mechanism after its trading range with other European currencies were deemed unsustainable.

"The news for sterling has gone from bad to worse," said Ian Stannard, a currencies strategist at BNP Paribas in London. He said that the pound could test resistance at $1.8180 area "before a corrective rebound develops," as sterling catches up with the dollar's recent move lower.

So far the pound has remained under pressure despite the broad weakening of the dollar as crude prices edge higher and concerns over the U.S. financial system weigh, with talk of substantial job losses at Lehman Brothers. Additionally, a story in The Wall Street Journal suggested that Jefferson County, Alabama, is facing what could be the largest ever municipal bankruptcy.

Dismal U.K. housing and retail sales data released Thursday pushed sterling down to a fresh two-year low of $1.8242 from trading levels that began the week at around $1.85. The pound plunged almost to a 12-year low Friday against a basket of currencies from the U.K.'s major trading partners.

On Friday, the dollar strengthened against the euro and the pound after the Chicago PMI, a closely watched measure of business activity, increased in August to its highest level since June 2007. That pushed the pound to a fresh two-year-low at $1.8187.

Chances that the pound could head still lower against the dollar and the euro would pose new strains on the U.K. economy. A falling currency value makes imports pricier, complicating the Bank of England's fight against inflation. Over time, a lower currency can help exporters compete in foreign markets, however.

Bank of England Governor Mervyn King said earlier this month that as a result of sterling's depreciation, import prices will be 10% higher this year than last. "We've seen nothing like that since the early 1990s," he said.

Stannard said that the situation will get even gloomier for sterling as "the bad news continues and it starts to look like the recession is deeper and longer than the market has priced in," adding that sterling could fall to $1.70 by early next year and will likely be below $1.80 by the end of the year.

A November rate cut would provide the major impetus for a fresh move lower for sterling, he added.

Bank of England arch-dove David Blanchflower, so far an isolated minority on the monetary policy council, this week called for a rate cut larger than 25 basis points to offset the faltering economy. His remarks helped fuel sterling's decline.

But Geoffrey Yu, a currencies strategist at UBS in London, said that sterling is likely to start to edge higher in September.

Yu said that the dollar's newfound strength has played a major role in sterling's breakneck dive, pointing out that "the trend of weak U.K. data has been clear for some time."

"The dollar move may run out of steam and sterling will be a bit more stable against the dollar," he said.

-By Rebecca Bundhun, Dow Jones Newswires; +44 (0) 207 842 9250; rebecca.bundhun@dowjones.com

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(END) Dow Jones Newswires

August 29, 2008 12:36 ET (16:36 GMT)


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