Bloomberg News

Pound Rises, Gilt Yields Drop to Lows as Euro Bond Rout Deepens

November 16, 2011

Nov. 15 (Bloomberg) -- The pound rose against the euro and gilts advanced, pushing 10- and 30-year yields to record lows, as investors sought the perceived safety of sterling-denominated assets after French, Italian and Spanish bond yields jumped.

The U.K. currency also gained versus the franc and the Australian dollar even as a report showed inflation slowed more than analysts forecast last month. It fell against the yen. Italian bond yields climbed above 7 percent, while French borrowing costs rose to a euro-era record relative to benchmark German bunds. Gilts stayed higher after Bank of England Governor Mervyn King said inflation will fall back “sharply” in the next six months.

“The economic fundamentals of Britain may not be brilliant, but some people see the pound as an alternative to the euro in an ugly contest,” said Jane Foley, a senior currency strategist at Rabobank International in London. “When tensions in the euro region rise then sterling does show evidence of having safe-haven bids.”

Sterling strengthened 0.3 percent to 85.47 pence per euro at 4:44 p.m. London time, after gaining by as much as 0.6 percent. It climbed 0.5 percent to 1.4527 Swiss francs, and slipped 0.6 percent to $1.5815.

The British currency has appreciated 1.8 percent in the past month, making it the second-best performer, after the dollar, among 10 developed-nation currencies tracked by Bloomberg Correlation-Weighted Indexes. It’s still 3.9 percent weaker in the past year, the indexes show.

Slowing Inflation

Inflation decelerated to 5 percent from 5.2 in September, the Office for National Statistics said today in London. The median forecast of 33 economists in a Bloomberg News Survey was 5.1 percent.

It is “possible that inflation could fall back more sharply given the existing margin of spare capacity in the economy, the substantial risks around the global economic recovery and the implications” for the U.K., King wrote in a letter to Chancellor of the Exchequer George Osborne, outlining what will be done to tame price gains.

King added that the main risk facing the U.K. economy comes from “the uncertain global economic outlook, and the extent to which weaker global economic conditions threaten the recovery.”

Gilts rose for a second day. Ten-year note yields fell four basis points to 2.15 percent after touching 2.11 percent. The 3.75 percent security due September 2021 rose 0.325, or 3.25 pounds per 1,000-pound face amount, to 114.12. Two-year yields were two basis points lower at 0.5 percent, while the 30-year rate reached as low as 3.09 percent.

Bearish Outlook

The 10-year breakeven rate, a gauge of market inflation expectations derived from the yield difference between regular and index-linked bonds, fell four basis points to 2.51 percentage points.

U.K index-linked bonds handed investors an almost 16 percent return this year, beating an almost 15 percent return from regular gilts, according to indexes compiled by Bank of American Merrill Lynch. Britain’s so-called linkers also outperformed their U.S. peers, which provided investors with a 14 percent return in the period.

The pound may rise further against the euro in the next three months, currency options show. The premium for contracts granting the right to sell the euro against the pound relative to those allowing for purchases rose to 2.05 percent today from 1.4 percent at the end of last month, according to so-called three-month 25-delta risk-reversal rates.

European Expansion

The British currency has gained against all but two of its 16 major peers monitored by Bloomberg this year. It has declined against the yen and the Swiss franc, and gained the most against the South African rand.

The Bank of England will publish its quarterly Inflation Report, and new economic projections tomorrow. The central bank’s August forecasts showed consumer price gains slowing below its 2 percent target by the first quarter of 2013. The bank is in the second of a four-month program of bond purchases, or quantitative easing, aimed at supporting the economy.

“The updated inflation projections are going to be weak, and it seems likely that they’re going to put through a pretty substantial downgrade to their GDP forecast,” said Simon Hayes, an economist at Barclays Capital in London. “I’m pretty confident QE will be increased further.”

--With additional reporting from Jennifer Ryan in London. Editors: Mark McCord, Nicholas Reynolds

To contact the reporter on this story: Anchalee Worrachate in London at aworrachate@bloomberg.net

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


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