In These New Times

Sharp fall in output routs pound

FT

24th October, 2008

Stocks slumped and the pound collapsed against the dollaryesterday as investors reacted to the worst decline in UK economic output since 1990 and investors around the world struggled to sell assets financed by cheap Japanese borrowing.

The grim day on the markets started with much worse than expected official figures showing the economy contracted by 0.5 per cent between July and September, stoking fears the recession would be deep and long.

The concern over the UK economy sent sterling into freefall as markets are now predicting interest rates could fall to 2.5 per cent by this time next year, down from 4.5 per cent now.

Against the dollar, the pound fell to close at $1.5751, 10 per cent lower than its rate on Monday morning. The pound also plunged against the euro, taking it to a lifetime low against the single currency. And against the Japanese yen, it dived to Y147.11, over 18 per cent less than at the start of the week. Traders said the slump of all leading currencies against the yen was part of a global stampede to reverse a massive “carry trade”, in which investors had borrowed at low Japanese interest rates to fund riskier but higher-yielding investments around the world.

“The magnitude of such historical market moves in currencies could only be the result of imploding hedge funds leading to massive liquidations,” said Ashraf Laidi, chief currency strategist at CMC Markets.

Equities, commodities and emerging markets suffered sharp declines. Redemption requests from investors in mutual and hedge funds intensified the wave of forced selling.

The FTSE 100 index plunged 5 per cent to 3,883, mirroring similar falls in European stock markets. In Asia, Japan’s Nikkei 225 index plunged 9.6 per cent to a five-year low, while Korea’s Kospi lost 10.6 and Hong Kong fell 8.3 per cent. All three markets have now fallen more than 50 per cent this year. In New York, the S&P500 was down 4.7 per cent in afternoon trading.

Brent crude oil prices fell more than $3 to below $63 a barrel, in spite of an Opec decision to cut production by 1.5m barrels a day to try to shore up the price.

Charlie Bean, the Bank of England deputy governor, said in a local newspaper interview the market turmoil was “possibly the largest financial crisis of its kind in human history”.

Economists said the 0.5 per cent third-quarter decline in economic output was terrible and signalled a much deeper recession than had been thought. Ben Broandbent of Goldman Sachs calculated the private sector part of the economy slumped 0.8 per cent, making the official figure “even weaker than it looks”.

Malcolm Barr of JPMorgan said the “dreadful” figures would force the Bank of England to cut interest rates by 0.75 percentage points in November and another 0.5 percentage points in December, taking the official rate down to 3.25 per cent by Christmas.