September 18, 2009 / 10:51 AM / 10 years ago

Sterling hits 4-month low vs euro on UK bank worries

* Sterling hits 4-mth low vs euro, stung by Lloyds news * Lloyds eyes cutting role in APS, govt tightens exit terms * Pound trims some losses on short covering after UK PSNCR

LONDON, Sept 18 (Reuters) - Sterling slumped to a four-month low against the euro on Friday, stung by news that the UK government was tightening the terms for one of the nation’s banks to exit its asset-protection scheme, which underlined the ongoing fragility of the UK banking sector.

The euro rose to 90.11 pence in early London trade, vaulting over the psychologically key 90 pence level to its highest since May, before paring losses as traders covered some short positions in the pound, which has taken a beating all week.

Sterling suffered broadly, hitting a two-week low versus the dollar and hovering around a two-month trough against the yen.

The pound clawed back from those levels after figures on UK public sector finances were not as dismal as markets had been expecting, although they were the worst for an August on record.

Lloyds Banking Group (LLOY.L) said on Friday it was in talks over a possible reduction in the number of toxic assets it might place in the so-called asset protection scheme (APS), encouraged by “improving economic conditions”. [ID:nLI109343]

The announcement from the part-nationalised bank came after Reuters reported on Thursday that the Financial Services Authority had set tougher-than-expected capital conditions on Lloyds’ potential exit from the scheme. [ID:nLH721093]

“The market has been swinging between optimism and pessimism about the UK financial sector,” said Steve Barrow, head of G10 currency research at Standard Bank in London.

“The Lloyds story is obviously not so good for sterling right now.”

Signs of weakness in the UK and global banking sector tend to hit sterling hard given the large role that the financial sector plays in the British economy.

By 1030 GMT, the euro EURGBP=D4 traded at 89.90 pence, up 0.2 percent on the day but staying below the four-month high hit earlier.

Sterling GBP=D4 was down 0.6 percent at $1.6350, having fallen as low as $1.6298 in early London trade, its lowest since Sept. 4. Against the yen GBPJPY=R it slid to around 148.60 yen, near its lowest since mid-July.

Some traders bought back the pound after dumping it in anticipation that data for UK’s public sector net cash requirement would be grim.

PSNCR stood at 10.379 billion pounds in August, lower than expectations for 12 billion pounds, but twice the level from a year ago and a record for the month of August [ID:nLI173994].

One trader said the figures were “only bad rather than very bad”, while analysts took a more pessimistic view, saying the need to rein in public spending will keep UK interest rates chained at a record low 0.5 percent, keeping sterling weak.

“At this rate, borrowing will overshoot UK Finance Minister (Alistair) Darling’s 175 billion pound forecast for the full year by around 50 billion pounds,” said Jonathan Loynes, analyst at Capital Economics.

“A severe fiscal squeeze is on the way, which will necessitate the maintenance of very loose monetary policy for a prolonged period.”

Other data showed that net lending to UK firms fell in July by the biggest amount since records began in 1998 [ID:nBOE002048].

Also knocking the pound were comments from Bank of England policymaker David Miles, who told the UK’s Independent newspaper the UK could be out of recession in six or nine months, but that the road to recovery could be long and slow [ID:nLI428333]. (Reporting by Naomi Tajitsu; Editing by Toby Chopra)

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