Nov. 6 (Bloomberg) -- The pound rose against the euro after the Bank of England cut its key interest rate by a greater-than- forecast 150 basis points, fueling optimism the faltering economy will recover faster than anticipated.

U.K. government bonds gained as the nine-member Monetary Policy Committee, led by Governor Mervyn King, lowered the benchmark rate to 3 percent, the lowest level since 1955. None of the 60 economists surveyed by Bloomberg forecast a reduction of that size. Britain's economy contracted 0.5 percent in October after shrinking by the same amount in the third quarter, the National Institute of Economic & Social Research said today.

``The market is now looking to reward proactive central banks,'' said Geoff Kendrick, a senior strategist in London at UBS AG, the second-biggest foreign-exchange trader. ``Clearly, the global economy, especially the U.K., is in a recession. Rate cuts now mean that growth will be better down the track.''

The pound advanced to 80.67 pence per euro by 5:52 p.m. in London, from 81.46 yesterday. It slipped to $1.5780, from $1.5910. The pound will strengthen to 79 pence per euro in a month's time, Kendrick predicted.

The U.K. economy is sputtering as the fallout from the global credit crisis curbs lending to companies and consumers. House prices fell 13.7 percent in the three months through October from a year earlier, the most in at least 25 years, HBOS Plc, the nation's largest home-loan provider, said today.

`Aggression Rewarded'

``Markets are looking more concerned about the extent to which economies are in a recession and are looking to central banks to rescue the economic system,'' said Kamal Sharma, a currency strategist in London at JPMorgan Chase & Co., which forecast a 1 percentage-point cut today. Larger cuts ``could be positive for sterling. Aggressive central banks may actually be rewarded.''

Britain's currency extended its advance against the euro after the European Central Bank lowered its main refinancing rate 50 basis points to 3.25 percent, as predicted by all but one of 55 economists surveyed by Bloomberg News.

``The market is disappointed with only a 50 basis-point cut from the ECB after the Bank of England's bigger-than-expected cut,'' said Daragh Maher, deputy head of global currency strategy in London at Calyon, the investment-banking arm of Credit Agricole SA. ``The ECB looks like it's behind the curve and the euro is being marked down on the back of that.''

Response to Crunch

The Bank of England's reduction was the biggest one-step cut since Sept. 18, 1992, the aftermath of Britain's ejection from Europe's currency-peg system that was the precursor to the euro.

Global policy makers are escalating their response to the worldwide credit crunch after a coordinated round of global cuts last month. The Swiss central bank unexpectedly trimmed its main lending rate by 50 basis points today. The Federal Reserve last month lowered its target interest rate for overnight loans to 1 percent, matching the lowest in a half century.

``Since mid-September, the global banking system has experienced its most serious disruption in almost a century,'' the Bank of England said in a statement accompanying today's decision.

U.K. government bonds rose, with the yield on the two-year gilt, which is more sensitive to interest-rate changes, falling 19 basis points to 2.55 percent, the lowest level since at least January 1992. The 4.75 percent security due June 2010 advanced 0.29, or 2.9 pounds per 1,000-pound face amount, to 103.39. The 10-year yield declined 10 basis points to 4.32 percent. Bond yields move inversely to prices.

Yield Spread

The difference in yield, or spread, between the two securities increased to as much as 177 basis points today, the widest since September 1996, steepening the so-called yield curve, as investors favored short-dated notes in anticipation of further rate reductions. A yield curve is a chart of bonds of different maturities.

``Today's story is the awful growth outlook,'' said David Scammell, a portfolio manager at Schroder Investment Management in London. ``We will definitely see more cuts. Despite the current level of yields, there's still value to be had by being overweight short-dated gilts and having curve steepeners.''

The yield on the December short-sterling futures contract fell 44 basis points in the past week to 3.68 percent today, indicating traders stepped up bets on more rate cuts.

King may need to lower the benchmark interest rate to zero, according to economists including former policy maker Charles Goodhart and Citigroup Inc.'s Michael Saunders.

``I don't think anybody believes this cut will be the end of it,'' Saunders said in an interview yesterday. ``The U.K. had one of the biggest credit and housing booms and the biggest drop in savings, so that makes us more exposed to the unwinding of it all.''

To contact the reporter on this story: Agnes Lovasz in London at alovasz@bloomberg.net

Last Updated: November 6, 2008 12:56 EST