Pound Falls, Gilts Gain as U.K. Economy Contracts While Inflation Rises

The pound posted weekly losses against most of its 16 most-actively traded peers as data showed the economy shrank and confidence plunged, fueling concern the government’s austerity measures are hurting growth.

The pound fell against the dollar for the first time in three weeks and declined against the euro for the fourth consecutive week on speculation the Bank of England may not be able to raise interest rates to fight inflation as growth slows. GfK NOP Ltd.’s index of sentiment fell 8 points from December to minus 29, the lowest since March 2009, data yesterday showed. The country’s gross domestic unexpectedly shrank 0.5 percent in the three months through December.

“We continue to see the pound as responding negatively to the stagflationary environment,” said Ian Stannard, a senior currency strategist at BNP Paribas SA in London. “We prefer to sell the pound against the dollar on rallies.”

The pound fell 1 percent in the week to $1.5838 as of 5:17 p.m. in London yesterday. Against the euro, it weakened 0.9 percent to 85.93 pence. The British currency declined the most against the yen in a month, shedding 1.6 percent to 129.99.

The currency has fallen 7 percent against nine of its developed-nation peers in the past 12 months, according to Bloomberg Correlation-Weighted Currency Indexes.

U.K. two-year government notes rose for the first time in four weeks as signs of economic slowdown prompted investors to seek a refuge in the safest assets. The yield on two-year securities fell eight basis points to 1.26 percent. The 10-year yield was five basis points lower on the week at 3.65 percent.

‘Tough Year’
“It’s going to be a tough year for gilt investors as the market is caught between data which suggested the economy is slowing and rising inflation,” said Nick Stamenkovic, a fixed- income strategist at RIA Capital Markets Ltd. in Edinburgh. “We see gains in gilts as short-lived as we believe policy makers will increasingly focus on inflation.”

Minutes released on Jan. 26 from the Bank of England’s monetary policy meeting earlier this month showed a second policy maker favored higher rates to curb consumer-price growth. Inflation accelerated to an eight-month high in December, rising 3.7 percent from a year earlier, as fuel and food prices climbed.
The bank’s Governor Mervyn King said on Jan. 26 that rising prices would be temporary. European Central Bank Executive Board member Lorenzo Bini Smaghi said on Jan. 27 that policy makers can no longer afford to ignore imported inflation after ECB President Jean-Claude Trichet pledged to do what’s needed to ensure price stability.

The U.K. 10-year breakeven rate, a market gauge of inflation expectations derived from the yield gap between nominal and index-linked bonds, rose nine basis points to 3.21 percentage points, the biggest weekly gain since the week ended Dec. 10.
U.K. gilts handed investors a 2.2 percent loss this month, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. It underperformed German bonds and Treasuries which lost 1.67 percent and 0.14 percent respectively.

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