British Pound Hits Multiyear Lows as Brexit Deals Blow to Economy

The British pound took a hit Friday, touching multiyear lows against the dollar and euro as the economy showed signs of being hampered by the U.K.’s political standoff with Europe.

The currency fell to $1.2057, its lowest since early 1985, and €1.0762, its lowest since October 2009, excluding the very extreme levels hit for a few minutes during the “flash crash” in late 2016. The pound recovered slightly later in the day, though it remains close to the more recent lows set against both currencies during 2017.

Britain’s economic woes—highlighted by data showing that second-quarter output shrank for the first time since 2012—are part of a series of global conflicts over trading relationships. That is slowing corporate investment and spending in many of the world’s leading economies, including the U.S. and China.

In the U.K., a sharp drop in manufacturing output in the second quarter and a rundown of inventories caused the economy overall to shrink 0.2% in the second quarter compared with the first quarter, official data showed Friday.

Yields on the 10-year U.K. government bonds have fallen substantially in recent months and on Friday fell to 0.481%, very close to all-time lows.

Britain’s big fight is over its future trading relationship with the European Union, which the country voted to leave in summer 2016. Three years later, it is still trying to work out how to exit. A new government, led by Prime Minister Boris Johnson, has taken a harder position over the past couple of weeks, saying it is much more prepared to quit without any agreement in place over future relations.

Jordan Rochester, an FX strategist at Nomura in Europe, believes the pound will fall further below both $1.20 and €1.07 until either the British Parliament steps up to stop a no-deal Brexit or Mr. Johnson softens his stance.

“We define a ‘hard-Brexit equilibrium’ as the level where Britain’s current-account deficit would start heading into balance and that would mean the pound at $1.14 to $1.18 and €1.05 to €1.02,” he said.

Despite the weak economic data and the pound’s troubles, economists don’t expect the U.K. to slip into recession, which is technically defined as two consecutive quarters of shrinking gross domestic product.

Almost all of the weakness was down to large swings in stock-building and running down inventories before and after businesses prepared for the original March 29-Brexit deadline, according to Thomas Pugh, a U.K. economist at research firm Capital Economics. When you strip out those swings, underlying growth didn’t contract, he said.

“There’s been a bit of a slowdown, but certainly not a collapse,” Mr. Pugh said.

Meanwhile, preparations for the new deadline on Oct. 31 could stoke the economy in the third quarter, said Azad Zangana, senior European economist and strategist at Schroders.

“If anything, we will probably see another, even larger buildup of inventories in the run-up to October, especially as the government’s default strategy is to exit the EU without a deal if one cannot be reached,” said Mr. Zangana. “Restocking will probably be enough to avoid a recession for now, but the risks further out are building.”

However, it could force a turn in policy from the Bank of England, which has been talking up the prospect of interest-rate increases.

Write to Paul J. Davies at paul.davies@wsj.com

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