Modern pencils are the descendants of ancient writing instruments.

In ancient Rome, scribes wrote on papyrus (an early form of paper) with a thin metal rod called a stylus, which left a light but readable mark. Other early styluses were made of lead. Today we still call the core of a pencil the “lead” even though it is made from nontoxic graphite.

Graphite came into widespread use following the discovery of a large graphite deposit in Borrowdale, England in 1564. Graphite left a darker mark than lead, but was so soft and brittle that it required a holder. At first, sticks of graphite were wrapped in string. Later, the graphite was inserted into wooden sticks that had been hollowed-out by hand! The wood-cased pencil was born.

The first mass-produced pencils were made in Nuremberg, Germany in 1662.

Modern pencils: Graphite and the clay are mixed together in the exact ratio to determine the hardness (or degree) of the pencil. Conventionally the centre point for grading is HB; this stands for Hard and Black, and has become the most popular degree.

Some time prior to 1565 (some sources say as early as 1500), an enormous deposit of graphite was discovered at the site of Seathwaite Fell near Borrowdale, Cumbria, England. The locals found that it was very useful for marking sheep. This particular deposit of graphite was extremely pure and solid, and it could easily be sawn into sticks. This was and remains the only deposit of graphite ever found in this solid form. Chemistry was in its infancy and the substance was thought to be a form of lead. Consequently, it was called plumbago (Latin for “lead ore”)[1][2]. The black core of pencils is still sometimes referred to as “lead,” even though it never contained the element lead.

http://en.wikipedia.org/wiki/Pencil#History