Sterling index hits 15-mth low as investors factor in rate cut risk

(updates prices)

By Jemima Kelly and Anirban Nag

LONDON, Feb 11 (Reuters) - Sterling fell to a 15-month low against a basket of currencies on Thursday, as investors fretted about slowing global growth prospects and their impact on the UK economy, with some pricing in risks of an interest rate cut in Britain.

British 10-year gilt yields slid to a record low of 1.2250 percent, before recovering to trade at 1.305 percent in afternoon trade. At its lowest, the 10-year gilt yield has shaved off nearly 75 basis points so far this year, and more than 35 basis points this week alone.

Interest rate markets are not pricing in a Bank of England (BoE (Shenzhen: 000725.SZ - news) ) rate hike until 2020. Sterling overnight interbank average rates - the very short-term interest rates which form the basis of lending costs to the economy - are pricing in the chance of a hike in five years' time.

But some in the money market are factoring in a good chance of a rate cut in the coming months, something that is likely to push the currency lower, traders said. The BoE's official bank rate has stood at 0.5 percent since March 2009.

Sterling was down 0.5 percent against the dollar at $1.4464, while the euro was nearly 1 percent stronger at 78.43 pence, having struck a 13-month high of 78.975 pence. All of which saw the sterling index drop to 86.5, its lowest since November 2014.

"Effectively, there is no prospect of a rate hike in the market any more, as far as the front-end is concerned," said John Wraith, rates strategist at UBS (NYSEArca: FBGX - news) . "There is now a nearly 50 percent chance of a cut over the next year or so priced in."

Also weighing on sterling were falling bank stocks in Britain and elsewhere in Europe. Britain's huge banking and financial sector helps in plugging the country's current account gap, and any risks to the sector weigh on the pound, traders said.

"There is risk-off sentiment and sterling right now is being treated as a risky asset," Rabobank currency strategist Jane Foley said.

In times of economic stress, countries or regions running current account surpluses - such as Japan, the euro zone and Switzerland - are seen as safer compared with those that have deficits and rely on foreign capital to finance the gap.

Britain and the United States fall into the latter category.

The pound has shed around 10 percent against the single currency over the last two months amid worries about the possibility that a coming referendum on Britain's EU membership could lead to a so-called "Brexit".

Rabobank's Foley said a Brussels summit at the end of next week, at which Prime Minister David Cameron will try to complete negotiations on a reform package to keep Britain in the EU, would be key for sterling. If the referendum is set for June, she said, the currency would be in for a turbulent few months.

The cost of protecting against big swings in sterling's exchange rate against the dollar over the coming week jumped to an 8-month high of 12.1 percent on Thursday. The summit will take place next Thursday and Friday. (Additional reporting by Andy Bruce; Editing by Mark Trevelyan and Andrew Heavens)