Pound Drops Below 2.00 - UK on the Verge of a Financial Crisis?

[B]Talking Points[/B]

  • Japanese Yen: dips into 114’s on UK worries
  • Euro: very quiet trading off EURJPY flows
  • Pound: Northern Rock problems grow
  • Dollar: Awaiting FOMC. Following NK story

Start of the new week and traders eyes are focused squarely on UK, where over the week-end the story of Northern Rock, the troubled mortgage lender, grew progressively worse as the company saw a run on its assets from customers worried about the safety of their funds. In fact the situation has become so serious that US Treasury Paulson, who made an unscheduled trip to London, will - along with UK Chancellor Darling - address reporters at 16:45 GMT today.
The shares of Northern Rock, UK’s fifth largest mortgage lender fell another 34% in London trade today, while the Guardian newspaper reported that customers began to queue outside its branches as early as 3 AM BST in order to withdraw their funds. With the crisis escalating by the moment the GBPUSD finally bucked under the pressure at the start of London open breaking the psychologically important 2.00 level. The pair held steady and actually rose in Tokyo trade on some carry buying in GBPJPY, but as the gravity of the situation became apparent, the last of the pound bulls capitulated and cable quickly fell.
The markets are clearly awaiting news from the regulators regarding the extent of the losses and the future financial status of Northern Rock. At this point, given the run on the bank, NR has no choice but to merge with a stronger competitor. According to Sunday Times, Lloyds TSB as poised to take over Northern Rock PLC (NRK.LN) before the troubled U.K. mortgage lender was forced to go to the Bank of England for an emergency credit line, but the deal was ultimately blocked by the BoE and the U.K. Financial Services Authority.
The UK monetary authorities now find themselves in a very precarious position. While BoE Governor Mervyn King clearly does not want the central bank to become the rescuer of every financial institution that made bad investment decisions, the Northern Rock situation threatens to transform itself into a full fledged financial panic that could bring UK money markets to a grinding halt. G10 policy makers are quickly discovering that tough talk may sound good in theory but in practice the only thing that matters to financial markets is confidence. Once investors lose it, the markets cease to function regardless of the facts. As that cold, stark reality stares Mr. King and company in the face the MPC will be forced to act.
As we noted on Friday, “Even if the current situation in UK lending sector is resolved with minimal loss of capital, the news over the past few days clearly shows the stress fractures in the UK economy and is likely to produce a much more cautious policy path from the BoE. Therefore expectations of a hike in UK rates to 6% before the end of 2007 appear to be less likely with each passing day and that fact should weigh on the pound going forward.”