Pound buckles as Bank highlights bleak outlook

LONDON (Reuters) - The pound was set to suffer its biggest monthly percentage drop since 1997, hitting 22-month lows against the dollar after new Bank of England inflation forecasts on Wednesday raised expectations of an interest rate cut.

Sterling’s trade-weighted index fell to an 11-1/2 year low as futures markets priced in a December rate cut after the Bank’s quarterly inflation report showed inflation spiking close to 5 percent before falling back dramatically.

The bank said it saw economic growth “broadly flat over the next year or so” and Bank Governor Mervyn King said there was a possibility of a quarter or two of falling output.

“The real economic data is undeniable. The economy is slowing really sharply and to forecast inflation below target in two years time was a huge signal,” State Street strategist Lee Ferridge said.

“Will they cut (rates from 5 percent) next month? Well, you can’t rule it out with the signal they have sent,” he added.

By 12:17 p.m., the pound had fallen more than one percent on the day to $1.8737, its lowest since October 2006 and down 5.2 percent so far this month. It is on track for its biggest monthly loss since January 1997, when it fell 6.4 percent.

It was also down 0.8 percent versus the euro at 79.28 pence. Trade weighted sterling fell to its lowest since January 1997 at 91.30.

SONIAs pricing indicated an 80 percent probability of a rate cut by December, compared with only around 10 percent before the report was released.

Technical analysts said sterling now stood at a critical juncture, with a weekly close below the 200-day moving average of $1.9021 seen as a major signal that it peaked. This chimed with the cue from economic fundamentals, analysts said.

“The tone is clearly dovish, with the economy now expected broadly to stagnate over the next year or so,” said Jonathan Loynes, chief European economist at Capital Economics.

“Against that background, we stick to the view that interest rates will eventually fall very sharply once inflation pressures finally recede.”

Earlier labour market data also boded ill for the pound and the broader economy as it showed the number of people claiming jobless benefits rose in July by the largest amount since 1992.

The Office for National Statistics said the claimant count rose for a sixth consecutive month, by 20,100, after an upwardly revised increase of 20,000 in June. That was the biggest jump since December 1992 and above forecasts for a 17,500 rise.

(additional reporting by Jamie McGeever in London)

Reporting by Veronica Brown; editing by Swaha Pattanaik