Pound sinks as the City bets on interest rate cut

Sterling fell more than two cents to $2.0386 after a sudden change in mood raised hopes that the Bank of England will cut rates tomorrow for the first time in more than two years.

The City was expecting the Bank to leave rates on hold at 5.75% until after New Year but experts today rushed to change their forecasts.

It followed a raft of bad news about the UK economy which piled pressure on the Bank to reduce rates now rather than wait.

Peter Dixon of Commerzbank said: "It is not often that interest rate expectations swing quite as much as they have done today. The interest rate support for the pound has been removed. The chances rates will be cut have risen, but even if it does not come tomorrow then certainly it will in the very near future."

The FTSE 100 index rose 83.5 points to 6398.7 as hopes of an interest rate cheered investors.

It came as members of the monetary policy committee, led by Governor Mervyn King, gathered at the Bank for their latest two-day meeting to set rates with fresh warnings over the economy ringing in their ears.

The Halifax said house prices fell for a third month in November - the first time this has happened since 1995 - while consumer confidence and the service sector are also struggling.

The Bank has raised rates five times since August last year to 5.75%, and pressure is mounting on it to cut them to stimulate the housing market, boost spending before Christmas and reinvigoratethe ailing economy. The credit crunch has also returned in the last month with borrowing costs in London's already tight money markets soaring. Libor - the London interbank offered rate, charged by financial institutions lending to each other - has hit fresh multi-year highs.

Only two MPC members, Sir John Gieve and David Blanchflower, voted for a reduction in rates last month, meaning three more need to vote for a cut this time. Likely candidates are swing voters Paul Tucker, Charlie Bean, Rachel Lomax and Kate Barker.

"I would be surprised if we didn't get all of them to vote for a cut," said Malcolm Barr of JPMorgan. Philip Shaw of Investec added: "It is not impossible that the committee gets a collective angst over growth prospects and we get a unanimous vote for a cut."

However, the Bank is concerned about inflation, nowrunning at 2.1%. It worries that if it cuts rates too soon, inflation will spiral out of control. It had its fingers burnt when inflation hit 3.1% in March - and King had to write to the Chancellor to explain why it was so far above the target of 2%.

What the top economists are saying

PHILIP SHAW of Investec: "The chances of a rate cut have risen sharply. They are not going to able to wait until February but it is a knife-edge decision tomorrow."
MALCOLM BARR of JPMorgan: "I find it difficult to imagine the Bank does not have enough reason now to start reducing rates."

HOWARD ARCHER of Global Insight: "We now believe the MPC will cut interest rates tomorrow."

RICHARD McGUIRE of RBC Capital Markets: "We now expect the Bank to cut rates tomorrow."

GEOFFREY DICKS of RBS: "The markets are now thinking 'why wouldn't they?' rather than 'why would they?'"

SUSHIL WADHWANI, former MPC member: "I have been surprised they haven't cut rates already."