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The pound falls as Britain gets bad GDP news

Britons were warned to expect a drop in living standards as real wages continue to slip. Above, a boarded-up London shop. Britons were warned to expect a drop in living standards as real wages continue to slip. Above, a boarded-up London shop. (Lefteris Pitarakis/Associated Press)
By Pan Pylas
Associated Press / January 26, 2011

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LONDON — Yesterday’s news of an unexpected downturn in Britain’s economy shocked investors, prompting a sharp drop in the pound to $1.58 and reigniting debate about the government’s plans to slash spending, raise taxes, and reduce public debt.

Figures showing a 0.5 percent quarterly drop in gross domestic product fueled speculation the British economy is heading back into recession — defined as two quarters of negative growth — and reined in expectations the Bank of England would start raising interest rates soon in response to stubbornly high inflation.

The figures, which are preliminary, followed four quarters of growth.

In the text of a speech, Bank of England governor Mervyn King appeared to indicate he was not in a rush to start raising borrowing costs, which could dampen growth. He argued a drop in living standards was an “inevitable price’’ for the financial crisis.

King conceded inflation would probably rise to between 4 and 5 percent in coming months, from 3.7 percent in December, but said price pressures would start to fall next year as the economic downturn continues to rein in wage increases.

In any case, King said, there’s little monetary policy can do to keep a lid on the prices of imports, such as food and oil.

“So unpleasant though it is, the Monetary Policy Committee neither can, nor should try to, prevent the squeeze in living standards, half of which is coming in the form of higher prices and half in earnings rising at a rate lower than normal,’’ he said.

King noted that real wages — the difference between pay rises and inflation — would probably fall again this year to levels no higher than in 2005.

“One has to go back to the 1920s to find a time when real wages fell over a period of six years,’’ King noted.

Britain plans sharper spending cuts than any of the other major global economies and how it fares is being watched closely.