Sterling fell more than 2 cents against the dollar on Thursday amid speculation that the Bank of England will need to cut interest rates to stimulate consumer spending after further disappointing retail sales figures.

The pound dropped 1.2 per cent to $1.8058 and 0.4 per cent against the euro to £0.662.

August retail sales were flat compared with the previous month, below the consensus forecast for a 0.1 per cent rise. However, July’s data was revised to show a fall of 0.6 per cent on the month, compared with the fall of 0.3 per cent previously reported. The year-on-year growth rate has sunk to 0.8 per cent, the lowest since May, which was the worst for almost a decade.

Fears that household spending will slow further unless interest rates are lowered pulled the rug from under the currency.

“Today’s numbers reinforce our expectations that continued weakness in consumer activity will leave the door open for further interest rate cuts later this year and throughout 2006,” Paul Dales of Capital Economics said.

The dollar hit a two-week high of $1.2194 against the euro as the single currency struggled ahead of Sunday’s German elections.

Worries that an unclear outcome at the polls could scupper or delay economic reform dominated, as commentators raised the possibility of a grand coalition after Sunday’s vote.

Expectations that Europe will press for greater flexibility in emerging Asian currencies at the forthcoming G7 meeting also weighed on the euro.

Among a slew of data from the US, the New York Fed’s Empire State survey attracted interest as it provided early reaction to Hurricane Katrina. The survey showed overall conditions for manufacturers fell to +16.97 from August’s +23.04, seen as a surprisingly resilient response.

The headline measure for US inflation increased to 3.6 per cent in August from 3.2 per cent in July, mainly due to sharp increases in oil and gasoline prices, but core inflationary pressures remained moderate.

Paul Mackel of ABN Amro suggested support for the greenback came from the US data that was not as bad as feared, particularly the Empire State survey, which was “relatively decent in the context of Katrina”.

However, the Philadelphia Fed business conditions survey slumped to 2.2 for September from 17.5 in August, well below the 14 predicted.

“All figures in the next few weeks will be very difficult to decipher because of Katrina,” Bob Munro of HIFX said.

“What really matters for the dollar is the expectation the Fed will continue to raise rates next week.”

The dollar strengthened 0.8 per cent to $1.2212 against the euro and 0.4 per cent to Y110.55 versus the Japanese yen, while the euro fell 0.4 per cent against the yen to Y135.02.

Switzerland left its three-month interest rate at 0.75 per cent, as expected, but warned growth was expected to continue to fall in the second half of the year.

In the accompanying statement, the SNB said it now assumed oil prices would persist at a high level, a change from its previous view that the price of crude would recede gradually.

Goldman Sachs viewed the accompanying statement as balanced and forecast rates rising by 0.5 percentage points by June 2006.

“The SNB reaffirms that monetary policy has been expansionary for a long time, a situation that will have to change once the recovery is confirmed. At the same time, the recovery so far has not yet translated into a stronger labour market and inflationary pressures remain very muted.”

ABN’s Mr Mackel suggested there had been “a minor disappointment for Swissie bulls who had been hoping for a signal, in the statement, of a December rate hike”.

The Swissie lost 0.9 per cent to SFr1.2672 against the dollar and 0.2 per cent to SFr1.5478 versus the euro.

The Taiwan dollar hit a 10-month low of T$32.873 against its US counterpart despite expectations that the central bank would lift interest rates.

When the decision came the bank raised the discount rate on 10-day loans to banks by 0.125 percentage points to an almost four-year high of 2.125 per cent.

The currency edged higher to T$32.77.

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