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Wednesday August 13, 2008 - 12:16:06 GMT
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FOREX NEWS-Sharp sterling slide on BoE report lifts dollar

Wed Aug 13, 2008 8:09am EDT

(Recasts, updates with quotes, comment. Changes byline)

* Sterling tumbles after BoE inflation report, below $1.88

* UK pound's fall fuels dollar gains; dlr index up 0.3 pct

* U.S. retail sales up next: seen -0.1 pct in July

By Jamie McGeever

LONDON, Aug 13 (Reuters) - Sterling fell to its lowest in almost two years against the dollar on Wednesday after the Bank of England signalled it could cut interest rates sooner rather than later, a drop which set the stage for a broad dollar rally.

The BoE said in its quarterly inflation report that inflation would spike up close to 5 percent before falling back dramatically to below its 2 percent target within two years, prompting a massive adjustment in UK interest rate markets.

UK rates markets moved aggressively to price in an almost 80 percent chance of a quarter point rate cut by the end of the year, fully discounted policy easing by January, and even attached a more than 50-50 chance of another cut by February.

Sterling's trade-weighted index hit its lowest since January, 1997 and its losses sparked a broad recovery in the dollar, which had been mostly weaker earlier in the day as dealers took profits from its hefty gains in recent weeks.

Some analysts said deteriorating growth in the UK, euro zone and other economies contrasted somewhat with the situation in the United States. Data on Tuesday showed the U.S. trade gap narrowed sharply, suggesting U.S. growth might not be as weak as previously feared.

"Given the shift in fundamentals highlighted by the inflation report and the U.S. trade balance yesterday, we can expect at least part of the (dollar) move we've seen in recent weeks will not reverse" in the near term, said Thomas Stolper, currency strategist at Goldman Sachs.

"Markets are getting whipped around. Yesterday we had (UK) inflation at new highs ... and today we have the BoE seemingly prepared to look through that," Stolper said.

At 1145 GMT sterling was down 1 percent on the day at $1.8770 <GBP=>, having fallen as low as $1.8737, its lowest in 22 months.

The euro was up 0.8 percent at 79.30 pence <EURGBP=>, while trade-weighted sterling fell as low as 91.3, a level not seen since January 1997 <=GBP>.

The euro reversed earlier gains against the dollar to trade down 0.25 percent at $1.4880 <EUR=>, and the dollar index rose almost a third of a percent to 76.35 .DXY, back toward the six-month high of 76.616 set the previous session.

The dollar was down 0.3 percent against the yen at 108.85 yen <JPY=>.


For more on the BoE inflation report and cross-asset market reaction to it, click on [ID:nBOE001516] and [ID:nLD254364].

Currency traders on Wednesday focused less on oil and equities than in recent weeks, looking instead to growth. Fears about the health of the global economy were fanned by data that showed Japan's economy shrank 0.6 percent in the second quarter.

This was in line with expectations but the annualised figure fell slightly faster than expected, by 2.4 percent. That report reinforced views the country had slipped into a recession after its longest period of expansion since World War Two. [JPGD1=ECI]

Second quarter German gross domestic product figures on Thursday are expected to show a 0.8 percent contraction in the euro zone's biggest economy.

This may encourage market participants to shrug off the lingering concerns over the U.S. banking sector and further unwind bets against the dollar that had, until last month, largely been extremely profitable.

"Longer-term players are short dollars and increasingly uncomfortable after last week's dramatic rally. The slide in financials may remind us that all is not well with U.S. fundamentals but for now the imperative is ... to rebalance positions in preparation for a more global recession," JP Morgan FX analysts said in a note.

"For now this entails buying dollars. It is highly doubtful whether today's retail sales numbers will alter this."

July U.S. retail sales data at 1230 GMT are expected to show a fall of 0.1 percent. See [ECON].

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