Pound Gains as U.K. Retail Sales Unexpectedly Jump Last Month

By Lukanyo Mnyanda

June 19 (Bloomberg) -- The pound rose to the highest level against the euro in almost three weeks after a government report showed retail sales in May surged the most since records began, prompting traders to bet on higher interest rates.

The currency also climbed to a one-week high versus the dollar after Bank of England Governor Mervyn King said policy makers will tolerate declining living standards to tackle price growth. The path of interest rates was ``uncertain,'' even with inflation at the highest level in at least a decade, King wrote in a letter to the government this week. Two-year gilts fell by the most in 10 days after the sales report.

``The number was a complete shock,'' said Derek Halpenny, head of currency research in London at Bank of Tokyo-Mitsubishi. ``In fact, it was such a shocker it's hard to believe. Understandably, we've seen a move up in sterling, but it's questionable how sustainable that will be.''


The U.K. currency climbed as much as 0.9 percent to 78.52 pence per euro, the strongest since June 2, and was at 78.56 pence by 4:11 p.m. in London, from 79.26 pence yesterday. It rose to $1.9727, the highest level since June 10, and was at $1.9718, from $1.9599 yesterday.

The pound may fall to 81 pence per euro over the next three months, Halpenny said. That compares with a median forecast of 80 pence by the end of the third quarter in a survey of 19 economists compiled by Bloomberg.

The 3.5 percent jump in U.K. retail sales was the most since the series started in 1986, and compared with a decline of 0.3 percent in April, the Office for National Statistics said. Economists in a Bloomberg News survey forecast a 0.1 percent drop. Sales rose 8.1 percent on the year, the most since 2002.

`Take Action'

The U.K. inflation rate rose to more than a percentage point above the central bank's target in May, a government report showed June 17, forcing King to write a letter of explanation to Chancellor of the Exchequer Alistair Darling.

Investors increased bets the central bank will lift rates in the third quarter. The implied yield on the short-sterling futures contract due September rose 21 basis points to 6.33 percent. The odds of a rate rise jumped to 35 percent, from 9 percent yesterday, according to a Credit Suisse Group derivatives index.

``The Monetary Policy Committee is prepared to take whatever action is needed to return inflation to the 2 percent target and to keep expectations of inflation in the medium term anchored to the target,'' King said yesterday in his annual Mansion House speech.

`Times are Tough'

Darling, speaking at the same event, said the economy is headed for a slowdown. He suggested the impact of a worldwide squeeze in borrowing costs is continuing and called on companies to keep a lid on pay raises that may embed faster inflation.

``Times are tough,'' Darling said. ``Today's inflation must be tackled. We cannot be complacent.''

The market ``has read King's comments as taking back some of the dovish tone in his letter,'' said Jeremy Stretch, a senior currency strategist in London at Rabobank International, the third-largest Dutch bank. ``That has probably helped provide some support for sterling.'' The U.K. currency may trade as high as 78.50 pence per euro in the next week, he said

The Bank of England will probably raise its key interest rate by a quarter-point in August to 5.25 percent to curb inflation, Malcolm Barr, chief U.K. economist at JPMorgan Chase & Co., said in an e-mail today.

Government bonds fell for a second day, pushing the yield on the two-year gilt up by as much as 16 basis points to 5.54 percent. It was last at 5.48 percent. The price of the 4.75 percent security due June 2010 fell 0.22, or 2.2 pounds pence per 1,000-pound ($1,978) face amount, to 98.63.

The 10-year yield rose 9 basis points to 5.24 percent. Yields move inversely to bond prices.

The pound has dropped this month amid speculation flagging growth will prevent policy makers from raising rates even as inflation accelerates. HBOS Plc, the U.K.'s biggest mortgage lender, said house prices will fall as much as 9 percent this year, more than it earlier forecast.

`` We suspect the market is over-reacting to the retail sales figures,'' currency strategists at Brown Brothers Harriman & Co. in New York including Win Thin wrote in a client note. ``Other indicators point to a weakening of the economy and suggest these numbers may be a fluke.''

To contact the reporter on this story: Lukanyo Mnyanda in London at lmnyanda@bloomberg.net