By Agnes Lovasz Oct. 3 (Bloomberg) -- The pound posted its biggest weekly drop versus the dollar since 1992 after a report showed U.K. services contracted the most in at least 12 years, fueling speculation the economy may already be in a recession and the Bank of England will cut interest rates soon. The U.K. currency lost 3.9 percent against the Japanese yen this week as manufacturing contracted, home values plunged and banks planned to scale back loans. The government seized mortgage lender Bradford & Bingley Plc this week as the world's financial system ground to a halt amid a cash shortage. The central bank will cut its key rate on Oct. 9, economists surveyed by Bloomberg News predicted. ``We've been pretty negative on the U.K. economy for a while and we think we're not just in for one or two quarters of negative growth,'' Robert Minikin, a senior currency strategist at Standard Chartered Plc in London, said in a Bloomberg Television interview. ``That could stretch to a year, maybe 18 months. The lack of policy response has left the pound in a powerless position.'' The U.K. currency pared its weekly loss against the dollar, rising to $1.7755 by 4:46 p.m., showing a drop of 3.8 percent in the week, the biggest since October 1992. The pound traded at 187.89 yen, from 185.80 yesterday, and 195.54 at the end of last week. Against the euro, it rose to 77.91 pence, from 78.34 yesterday, gaining 1.7 percent since Sept. 26. Services Shrink An index based on a survey of about 700 service companies fell more than forecast to 46 in September, from 49.2 a month earlier, the Chartered Institute of Purchasing and Supply said today. Manufacturing contracted at the fastest pace in 16 years amid a credit squeeze that has crippled bank lending, the group said earlier in the week. The pound slipped to a three-week low against the dollar yesterday after U.K. house prices slid in September by the most since at least 1991, giving the Bank of England added reason to lower interest rates in an effort to revive the economy. Policy makers will cut the 5 percent benchmark rate by a quarter point when they meet Oct. 9, according to the median estimate in a Bloomberg survey of 35 economists. Two days ago they predicted no change in rates. The bank will lower it by a half point next week, the biggest reduction since 2001, Citigroup Inc. Chief Western European Economist Michael Saunders said. BNP Paribas SA also changed its forecast today to a half-point reduction next week. Currency Forecast The British currency will weaken to $1.70 in early 2009 and to $1.60 later next year ``as the Bank of England finally starts cutting interest rates aggressively,'' Minikin said. The implied yield on the March short-sterling futures contract was at 4.70 percent, from 5.07 percent a week ago, indicating traders added to bets for a reduction in rates. U.K. government bonds declined, paring their weekly advance, after demand for the safest assets dropped on optimism the U.S. House of Representatives will approve a $700 billion financial-rescue package. At least 18 House members said they will drop their opposition to the rescue bill and support it. The plan failed by a dozen votes earlier this week. The drop sent the yield on the 10-year gilt 3 basis points higher to 4.40 percent, still down 14 basis points in the week. The 5 percent security maturing March 2018 fell 0.21, or 2.1 pounds per 1,000-pound ($1,774) face amount, to 104.63. The yield on the two-year gilt rose 6 basis points to 4.01 percent, down 22 basis points this week. Bond yields move inversely to prices. Britain entered a recession in July, according to the European Commission and the Confederation of British Industry, the country's biggest business lobby. To contact the reporter on this story: Agnes Lovasz in London at alovasz@bloomberg.net

Source