Bloomberg News

Pound Weakens, Gilts Rise on Rate Outlook as Retail Sales Slump

June 16, 2011

June 16 (Bloomberg) -- The pound weakened against the dollar and gilts rallied after data showed U.K. retail sales slumped more than economists forecast, adding further weight to calls for the Bank of England to keep interest rates on hold.

Short-sterling futures rose, signaling traders cut bets on an increase in borrowing costs. Governor Mervyn King yesterday said officials should hold rates at a record low because weak growth in wages signals the current above-target inflation will prove temporary. Retail sales fell 1.4 percent from April, the Office for National Statistics said, as sentiment was hurt by the government’s budget squeeze. The drop exceeded the 0.6 percent median forecast of 24 economists in a Bloomberg survey.

“Most expected that the numbers would be low or bad, but only a few expected such rubbish numbers,” said John Hydeskov, chief analyst at Danske Bank A/S in London. “With private spending now dropping off the top of a cliff, austerity measures are really starting to bite.”

The pound fell as much as 0.7 percent to $1.6079, the lowest since May 24, before trading at $1.6136 as of 4:37 p.m. in London. Sterling fell 0.2 percent against the euro to 87.75 pence and depreciated 0.7 percent to 130.22 yen.

Investors now expect the central bank to next increase rates in March next year, forward contracts on the sterling overnight interbank average show. As recently as February, traders were betting on an increase as soon as May of this year, data from Tullett Prebon Plc showed.

King Speech

The implied yield on the June 2012 short-sterling futures contract fell four basis points to 1.17 percent.

“Subdued rates of increase in average earnings, as well as remarkably, some might say disturbingly, low growth rates of broad money have provided strong signals that inflation will fall back in due course,” King said in a speech in London late yesterday. A rate increase “would have meant a weaker recovery, or even further falls in output” and “a risk of inflation falling well below the target in the medium term.”

Sterling was supported versus the euro as European officials failed to reassure investors they are close to reaching a solution to the region’s debt crisis.

Greek and Portuguese two-year yields climbed to records today. Germany has clashed with the European Central Bank this week over how to engage private investors in the next stage of rescuing debt-stricken Greece.

Cabinet Shuffle

Prime Minister George Papandreou will reshuffle his Cabinet today and seek a confidence vote, battling to control a shrinking majority and pass austerity measures demanded by international lenders to ensure the next tranche of aid.

“I would, under normal circumstances, expect to see a much bigger rise in euro-sterling on very bad data like this,” said Hydeskov. “The pound is keeping up against the euro due to the European debt crisis. If I wasn’t for that I have no doubt that we would be trading above 90 pence.”

U.K. government bonds advanced, with the yield on 10-year gilts five basis points lower at 3.19 percent, after earlier reaching 3.17 percent the lowest since Nov. 12. The yield on two-year notes was three basis points lower at 0.75 percent.

The Debt Management Office plans to auction 4 billion pounds ($6.5 billion) of 28-, 91- and 182-day bills tomorrow.

Gilts have returned 2.7 percent this year, compared with a 3.3 gain on Treasuries, according to European Federation of Financial Analysts Societies and Bloomberg indexes.

--With assistance from Garth Theunissen in London. Editor: Mark McCord

To contact the reporter on this story: Lucy Meakin in London at lmeakin1@bloomberg.net

To contact the editor responsible for this story: Daniel Tilles at dtilles@bloomberg.net


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