Pound Falls, Gilts Rise as House Prices Drop Most Since 2001

By Andrew MacAskill

July 28 (Bloomberg) -- The pound fell against the euro and the dollar and gilts rose after U.K. house values dropped in July by the most in at least seven years, increasing concern the economy is headed toward a recession.

The average cost of a residential property in England and Wales slipped 4.4 percent from a year earlier, Hometrack Ltd., a London-based research company, said today in a statement. That's the biggest annual drop since the index started seven years ago. Prices fell 1.2 percent from June.

``This is more bad news coming out of the housing market and adds to the growing sense the economy is slowing,'' said Grant Lewis, the London-based head of fixed-income research at Daiwa Securities SMBC Europe Ltd. ``That puts a bit of downward pressure on sterling given the expectation of rate cuts.''

The British currency weakened to 79.24 pence as of 11:26 a.m. in London, from 78.87 pence at the end of last week. It was at $1.9872, from $1.9916. The pound dropped 7.1 percent versus the euro this year and is little changed against the dollar.

Bank of England data on mortgage approvals to be published tomorrow are likely to signal further weakness in the housing market, according to a survey of analysts. The number of loans agreed for home purchases dropped to 37,000 in June, from 42,000 in May, the median of 24 forecasts gathered by Bloomberg shows.

`Leading Indicator'

``These figures are the leading indicator of where prices are going in the future, and if they come in weak as expected then it points to further declines the remainder of the year,'' said Adam Cole, the head of global currency strategy in London at RBC Capital Markets, the nation's biggest lender.

Slowing economic growth and the prospect of cuts in the central bank's benchmark interest rate will weaken the pound to $1.90 and 79 pence per euro by year-end, according to the median forecast of analysts and strategists surveyed by Bloomberg. The central bank left its key rate at 5 percent on July 10.

The odds of policy makers cutting interest rates for a third time this year was unchanged, with the implied yield on the December short-sterling futures contract at 5.81 percent.

U.K. government bonds rose, with the yield on the 10-year gilt declining 3 basis points to 4.96 percent. The price of the 5 percent security due March 2018 climbed 0.2, or 2 pounds per 1,000-pound ($1,987) face amount, to 100.26. The two-year note yield fell 4 basis points to 4.93 percent. Bond yields move inversely to prices.

Bonds advanced last week, with the 10-year yield slipping 5 basis points to 4.99 percent.

Gains in gilts will lower the yield on the 10-year note to 4.89 percent by year-end, according to a Bloomberg survey.

To contact the reporter on this story: Andrew MacAskill in London at amacaskill@bloomberg.net