Pound hits 22-month low against the dollar

The pound slid to a 22-month low against the dollar and was on track for its steepest monthly drop in over 11 years yesterday as negative sentiment mounted on the economy, raising expectations for a rate cut.

The Bank of England's quarterly inflation report on Wednesday gave a gloomy prognosis for the economy, and said inflation would fall below the central bank's two per cent target in two years if interest rates were held at five per cent.

Inflation at more than double the Bank's target had kept expectations of rate cuts on the back-burner despite data showing the economy in poor shape and heading towards a possible recession.

But the central bank's suggestion that inflation is set to slide ramped up expectations for a rate cut by the end of the year, denting the currency's yield advantage. "We saw a switch in focus from the Bank of England which is now seeing through short term inflation problems. This is what sent sterling spinning," said Nicola Chadwick, international economist at Commonwealth Bank of Australia.

On a trade-weighted basis, the pound edged off an eleven-and-a-half- year low set the previous session to trade at 90.9.

A Reuters poll of economists forecast a 40 per cent median probability of an interest rate cut by year-end, with rates falling to 4.25 per cent by the third quarter of next year.

"A rate cut before year-end is not guaranteed," said ING in a note to clients. "Nonetheless, aggressive rate cuts are likely through next year as recession risks mount."