Fears for Us Industry Edge Dollar Closer to 50p Mark

Sterling moved to within two cents of the $2 level last night after a recession-warning signal from America's manufacturing base led to a fresh wave of frantic selling of the dollar on jittery foreign exchanges.

Speculation that the Federal Reserve, the US central bank, might be forced into an early cut in interest rates to revive the flagging economy pushed the pound to almost $1.9850 at one stage yesterday.

With the dollar having already suffered a week of falls, the trigger for the latest bout of selling was the release of the Institute for Supply Management's monthly snapshot of American industry. This showed the overall index dipping below 50 - the cut-off point between an expanding and contracting manufacturing sector - for the first time in three and a half years.

Markets seized on the ISM survey as evidence that the deterioration in the housing market was spreading across the world's biggest economy.

Sterling later fell back slightly to about $1.98 as dealers took profits but analysts believe a fresh assault on the $2-level will be mounted over the coming days. The last time the dollar was worth less than 50 pence was on September 9 1992, a week before Black Wednesday.

"Overall, this is consistent with the view that the US economy is moderating and could prompt a Fed rate cut in 2007," said Omer Esiner, senior market analyst at Ruesch International in Washington, DC. "Buying dollars is a hard case to make right now. There's just no compelling reason to be long in dollars going into the weekend."

The dollar fell against all major currencies yesterday, losing well over a cent against the pound and three-quarters of a cent against the euro to end the day at $1.33. Turbulence on the foreign exchanges spread to the equity markets, where shares in both London and Wall Street were under pressure. The FTSE 100 closed 27.3 points lower at 6021.5, while the Dow Jones average was 40 points lower in morning trading on Wall Street.

Wall Street was taken aback by the weakness in the ISM, with supporting evidence for the downturn in the economy provided by a 1% decline in construction spending in October. Paul Ashworth, senior US economist with Capital Economics, said it was "getting harder for the Fed to argue that the housing slump is not affecting the wider economy. The downside risks to growth must be close to usurping the upside risks to inflation as the most pressing concern".

Although attention this week has focused on the shopping bargains on offer to British consumers visiting the US, some analysts warned that the strength of the pound might have a detrimental impact on UK exports across the Atlantic. By the close of trading in Europe last night sterling was at a 14-year high against the dollar and a six-year high against a basket of global currencies.

Britain's own version of the ISM - the Chartered Institute of Purchasing and Supply index- also weakened in November. The CIPS index dropped from 53.5 in October to 52.6. Ashraf Laidi, chief foreign exchange analyst for CNC markets, said he doubted whether the pound would break through the two-dollar barrier due to "emerging signs of weakness in the UK's manufacturing sector and continued cooling in labour markets". The Bank of England's monetary policy committee meets next week and is expected to leave the cost of borrowing on hold at 5%.