Pound Drops Versus Dollar on China Tightening, Korea ‘Unease’

The pound posted its biggest weekly drop against the dollar in more than six months as concern that China is moving to slow its economy and tensions between North and South Korea diminished demand for riskier assets.

The U.K. currency fell below $1.56 for the first time since September as North Korea’s state-run news agency said planned naval exercises by South Korea and the U.S. moved the peninsula “closer to the brink of war.” Speculation grew that China will increase borrowing costs to contain consumer prices after inflation sped up to its fastest since 2008.

“The tensions in Korea, policy tightening in China and the likelihood of more to come add to the sense of unease,” said Daragh Maher, deputy head of global foreign-exchange strategy at Credit Agricole Corporate & Investment Bank in London. “In this kind of more nervous environment in general, we’re getting a dollar bid and by extension sterling is losing some ground.”

The pound dropped to $1.5602 as of 4:30 p.m. in London yesterday, a weekly decline of 2.4 percent. It’s the third weekly decline against the dollar in a row and the biggest since the week ending May 7. Sterling gained 0.9 percent versus the euro to 84.82 pence.

The U.K. currency depreciated against 11 of its 16 most- actively traded peers this week.

The U.S. sent an aircraft carrier, the USS George Washington, to the Yellow Sea off the western coast of the Korean peninsula in a show of strength after North Korea shelled a South Korean island on Nov. 23. Global stocks declined as yesterday North Korea threatened a “shower of terrifying fire” in response.

Bank of England

Data released in the week showed U.K. gross domestic product expanded 0.8 percent in the third quarter, unchanged from initial government estimates. The Confederation of British Industry said its retail-sales index rose in November and stores expect momentum to continue in the run-up to Christmas.

Members of the Bank of England’s Monetary Policy Committee speaking on Nov. 25 gave no indication the central bank plans to step up so-called quantitative easing to support the economic recovery. The committee remains split three ways on a possible extension of its asset-purchase program, known as QE2.

Bank Governor Mervyn King told lawmakers in London that policy makers view inflation risks as “broadly balanced” at present and are ready to tighten or loosen policy as needed.

MPC Testimony

“Testimony from MPC members showed quite a range of opinion,” said Maher. “That would be a little more supportive of sterling to the extent that it would make it less likely that we get QE2, but because the dollar’s been so strong in this nervous market, it’s really only been reflected in a bit of euro-sterling weakness rather than pound-dollar upside.”

U.K. government bonds rose in the week on demand for the safety of fixed-income assets amid speculation Europe’s sovereign-debt burdens are worsening.

Borrowing costs for Europe’s most indebted nations reached record highs as Ireland’s capitulation in accepting a rescue package for its banking industry stoked concern that other countries will have to seek aid. The Financial Times Deutschland yesterday reported euro-area policy makers are pushing Portugal to request support to shore up its economy and stem the risk of a bailout being needed in Spain.

The 10-year gilt yield slumped four basis points to 3.34 percent, paring last week’s three month high. The two-year note yield dropped seven basis points in the week to 1.02 percent.

Gilts have returned 6.9 percent this year, compared with a 7.1 percent gain for German bonds and 7.3 percent for U.S. Treasuries, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies.

Sterling has weakened 3.8 percent against a basket of its developed-country peers this year, according to Bloomberg Correlation-Weighted Currency Indexes, making it the third-worst-performing currency after the euro and Norwegian krone. It has appreciated 0.8 percent in the past month.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE