Pound Drops on Concern Credit Market Crisis Spreading to U.K.

Aug. 21 (Bloomberg) -- The pound dropped against the euro on concern the credit-market crisis is spreading to Europe's second- biggest economy.

The pound held near a three-month low reached yesterday as Odey Asset Management, a London-based hedge fund, reported a fall in profits, and after hedge fund manager Solent Capital Partners LLP said it may be forced to sell assets after it was unable to borrow in the commercial-paper market yesterday.

``The markets are really nervous and in that environment stories in the press about U.K. institutions exposed to U.S. subprime losses don't help,'' said Martin McMahon, a currency strategist at Credit Suisse Group in Zurich. ``Nobody really knows what anyone else has on their balance sheets.''

Against the euro the pound dropped to 68.02 pence by 5:43 p.m. in London, from 67.79 pence yesterday, when it reached the lowest since May 22.

The U.K. currency also fell to $1.9817, near a two-month low, from $1.9878 on Aug. 20.

Britain's currency extended its decline after the Bank of England said it loaned 314 million pounds ($621 million) from its standing facility. That's the first time a commercial bank has asked for additional money since July 17.

The standing facility allows U.K. banks to borrow from the BOE at 1 percentage point above the benchmark interest rate, currently at 5.75 percent.

Corporate Bond Risk

The risk of owning European corporate bonds rose, credit- default swaps trading showed, on concern money markets won't refinance about $550 billion of commercial paper coming due, forcing investors to sell assets.

Contracts on the iTraxx Europe Index rose 0.75 basis point to 49 basis points, JPMortgan Chase & Co. prices show.

The pound remained lower versus the dollar after U.S. Treasury Secretary Henry Paulson said market volatility and concern about subprime mortgages will ``take time'' to subside.

``You're going to see liquidity return to normal,'' Paulson said in a CNBC interview from Washington.

Paulson is meeting with Fed Chairman Ben S. Bernanke and Senate Banking Committee Chairman Christopher Dodd today to discuss how to handle problems roiling the credit market.

Gilts advanced, rising with European bonds and Treasuries, as a decline in stocks stoked demand for the safest assets.

The yield on the 4 percent gilt due September 2016 fell 6 basis points to 5.00 percent, while the yield on the 4 percent note maturing March 2009 slipped 8 basis points to 5.26 percent. Yields move inversely to bond prices.