May 30 (Bloomberg) -- The pound weakened to a four-month low against the dollar amid speculation the fallout from Europe’s debt crisis is spreading and will harm the outlook for the U.K. economy.
Sterling dropped for a third day against the yen as Nobel laureate Paul Krugman said the U.K. government should drop its commitment to fiscal cutbacks and boost spending to avert an extended downturn. Gilts jumped, with five- and 10-year yields dropping to records, after Bank of England Markets Director Paul Fisher said U.K. companies need to protect against the risk of a euro breakup. The cost of insuring Spanish government bonds against default rose to an all-time high.
“Sterling is going to increasingly feel the negative effects coming from the euro region and the news about the Spanish banking system,” said Ian Stannard, head of European currency strategy at Morgan Stanley in London. “Sterling has a lot of linkages to the euro region through the banking system and via trade, so it will come under pressure as the situation in the euro region intensifies.”
The pound fell 0.7 percent to $1.5538 at 4:13 p.m. London time after dropping to $1.5523, the weakest since Jan. 23. The U.K. currency slid 1.3 percent to 122.70 yen, and was little changed at 79.83 pence per euro.
Morgan Stanley forecasts the pound will depreciate to $1.53 by year-end, Stannard said.
The euro slumped to a two-year low against the dollar as Spain struggled to bolster its banking system amid surging borrowing costs. Credit-default swaps linked to Spanish government debt climbed 23 basis points to 583 basis points, according to data compiled by Bloomberg.
“No one is trying to anticipate a euro breakup, but you just can’t rule it out,” Fisher said according to an interview in the Leicester Mercury. Prime Minister David Cameron and Bank of England Governor Mervyn King met on May 28 to discuss plans to insulate the British economy from any escalation of the euro-area debt crisis.
The 10-year gilt yield fell 13 basis points, or 0.13 percentage point, to 1.65 percent after declining to 1.637 percent, the lowest since Bloomberg began compiling the data in 1989. The 4 percent bond due March 2022 gained 1.305, or 13.05 pounds per 1,000-pound face amount, to 121.145.
Five-year note yields also declined to an all-time low, at 0.659 percent.
Officials should realize “this is the time for the government to act as the spender of last resort,” Krugman said yesterday in a speech at the London School of Economics. “If you want to worry about debt and deficits, fine, but this is the time, to quote St. Augustine, to say ‘Oh Lord, make me chaste and continent, but not yet.’”
The U.K. economy slid into its first double-dip recession since the 1970s in the first quarter amid the financial crisis in Europe and Cameron’s commitment to the biggest fiscal squeeze since World War II.
The focus on reducing the U.K.’s ratio of debt to gross domestic product doesn’t need to be the center of policy because Britain, like the U.S., has the benefit of being able to borrow in its own currency, Krugman said.
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