Currencies

THE POUND is expected to fall, paring last week's two pfennig gain against the mark, on expectations that UK interest rates will fall further and faster than rates in Europe.

"I'm certainly expecting further rate cuts in the spring," said Brian Turner, fund manager at Henderson Investors. "I'd sell sterling above DM2.80."

The Bank of England has already cut rates by 75 basis points in the past two months, and recent economic reports have done little to damp expectations that the UK economy will slow.

On Friday, the pound was little changed at DM2.8278 from DM2.8293 the day before. It fell against the dollar for the first day in five, to $1.6570 from $1.6615.

The benchmark lending rate now stands at 6.75 per cent, compared with Germany's 3.30 per cent. The prospect of lower rates reducing the return on sterling deposits has already pushed the pound down 14 pfennigs against the mark since the end of August.

"UK interest rates are still well above the European average," said Stuart Kinnersley, at Nikko Global Asset Management. "If the interest rate differential is eroded, that has to be a drag on sterling."

Reports last week have boosted the outlook for lower rates. They showed that the British manufacturing industry activity is stagnant, the trade deficit widened in September to a record, and economic growth slowed more than expected in the third quarter.

The implied yield on the December sterling interest-rate futures contract, which is a measure of UK rate expectations, fell 6 basis points last week to 6.73 per cent.

That suggests that traders increasingly expect a rate cut when the Bank of England's rate panel next meets on 9 and 10 December.

"They'll go for at least a quarter of a point," said Mohamed Sbitri, a currency trader at Gulf International Bank, who expects the pound to fall to DM2.75 in the coming weeks. "There's too much negative news out of the UK for them not to."

More gloomy evidence on the economy could come in the week ahead. Analysts said they would focus on the CBI's distributive trade survey and the Chartered Institute of Purchasing and Supply's survey of service activity, both released on Thursday, for clues on when the Bank of England will next reduce rates.

"If these two surveys fail to show a rebound from quite poor out-turns last month, that could tip the MPC into a December easing," said David Brickman, an international economist at PaineWebber International.

In Germany, meanwhile, all 35 investors and security traders polled last week said the Bundesbank will not cut borrowing costs before the start of the single currency in January. Four of those surveyed said the ECB will announce a rate cut when it meets in December, just before it officially begins setting rates.

On Friday, the ECB president, Wim Duisenberg, hinted the bank may cut borrowing costs next year to sustain growth and cut joblessness in the 11 countries adopting the euro. "In specific circumstances, if production, inflation and employment all move in the same direction, monetary policy can play some role in stabilising output and employment growth without endangering price stability."

"We see this as confirming our expectation of a 3 per cent ECB repo rate very early [in the first quarter[," said Alison Cottrell, the chief economist at PaineWebber International.