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Sterling hits record low vs euro, currency basket

  Sterling tumbled to a record low against the euro and a basket of currencies on Monday, stung by the ongoing view that a weak UK economy will require more interest rate cuts which will keep UK rates lower than those in the euro zone.

The euro climbed as high as 97.18 pence in early London trade, edging closer to parity after figures showed that UK home prices continued to fall in December, taking them nearly 10% lower since the start of the credit crunch in August 2007.

A shrinking UK economy, ongoing deterioration in the housing market and rising unemployment are contributing to an grim outlook for the nation in 2009, which has battered sterling across the board.

This has fuelled the belief that the Bank of England (BoE) will cut rates further -- and perhaps even explore other options to shore up the economy during in the recession -- even after an aggressive round of cuts has left rates at a five-decade low of 2.0%, lower than 2.5% in the euro zone.

“There’s a sense that UK rates will fall closer to zero, and that the BoE may be forced into some sort of quantitative easing, while there’s no sense of that in the euro zone,” said Daragh Maher, senior currency strategist at Calyon in London.

He added that the negative view of the UK economy will continue to weigh on the pound, although additional weakness in the euro zone economy may start to chip away at the euro’s appeal in the new year.

The euro has soared roughly 32% against sterling this year -- jumping a record 17% this month alone -- and its rise on Monday pushed the UK currency down to 74.7 on a trade-weighted basis, its lowest according to daily records kept by the BoE which date back to 1990.

Despite its losses against the euro, sterling managed to eke out gains against a broadly weaker dollar, pushing up 0.4% on the day to $1.4705. Figures on Monday from property consultant Hometrack showed that housing prices in England and Wales fell 8.7% in 2008. They fell 0.9% in December, showing that prices have now fallen consistently over the last 15 months and 9.3% since the credit crisis began.

Along with figures from the Chartered Institute of Personnel and Development at the weekend showing that 600,000 UK jobs could be lost in 2009 due to the recession, Monday’s data helped to worsen already negative sentiment on sterling.

Higher interest rates in the euro zone has increased the euro’s appeal against the pound as it has narrowed the yield spread between euro zone and UK government bonds. The yield on 10-year UK bonds hovered around 3.114% on Monday, near a record low of 3.008% hit last week, while the yield on its euro zone counterpart fell to an all-time trough of 2.909%.

Both yields have tumbled due to economic deterioration and falling interest rates but the bigger fall in UK yields due to the BoE’s particularly aggressive easing has shrank the yield spread between the two to around 0.112% earlier this month, the narrowest yield advantage for sterling in a decade. (Reuters)