Pound Drops Versus Euro on Bets Economy Heading for a Recession

By Lukanyo Mnyanda

Aug. 27 (Bloomberg) -- The U.K. pound fell for a second day against the euro on speculation a deepening slump in the nation's housing market may force the central bank to cut interest rates.

The pound was near a two-year low versus the dollar as Taylor Wimpey Plc., the largest U.K. homebuilder, reported a first-half loss of 1.4 billion pounds ($2.6 billion), adding to concern the economy is entering a recession. Nationwide Building Society will tomorrow say house prices fell for a ninth month, according to economists surveyed by Bloomberg News. The difference in yield between 10-year gilts and German bunds slipped to the narrowest in seven months.

``There are a variety of broader negative stories floating around that are sterling negative,'' said Simon Derrick, chief currency strategist in London at Bank of New York Mellon Corp. ``That's not helping the cause.'' The currency may drop to $1.80 versus the dollar in a month, he predicted.

The U.K. currency fell to 79.98 pence per euro by 1 p.m. in London, from 79.65 yesterday. It dropped to 80.04 pence on Aug. 25, the lowest level since Aug. 14. The pound was at $1.8456, paring its loss this month to 6.6 percent. It's headed for the biggest monthly drop since October 1992, when it fell 12 percent.

Taylor Wimpey and other builders are being forced to cut operations and shed jobs as the economy, Europe's second-largest, reels from the most widespread housing slump in 30 years. Bank of England Governor Mervyn King said this month the U.K. faces a ``difficult and painful adjustment'' as falling house prices and rising inflation hurt consumer spending.

The pound dropped versus the dollar in each of the past five weeks, the longest losing run since February 2006. It slipped last week after a government report showed economic growth stagnated in the second quarter, adding to pressure on the central bank to cut interest rates to revive the economy.

Gilts Reverse Gains

Gilts dropped with Treasuries and European bonds, reversing an earlier gain that pushed the yield on the 10-year bond to the lowest level since April 16.

The 10-year yield rose 2 basis points to 4.51 percent. The 5 percent security due March 2018 fell 0.15, or 1.5 pounds per 1,000-pound face amount, to 103.76. Two-year gilt yields, which are more sensitive to interest-rate expectations, climbed 3 basis points to 4.51 percent. Bond yields move inversely to prices.

Two-year gilts advanced the most in two weeks yesterday as an industry report showed mortgage approvals held near the weakest level in a decade. The number of mortgages approved last month slumped 65 percent in the year and their value fell to the least since 1998, the British Bankers' Association said.

The spread between 10-year gilts and their German equivalent narrowed 4 basis points to 34 basis points, the least since Jan. 11. The gap was 69 basis points on Feb. 25, which was the widest this year.

``The economic situation in the U.K. is getting worse and we expect gilts to remain supported as a result,'' said Giuseppe Maraffino, a bond strategist in Milan at UniCredit Markets & Investment Banking, a unit of Italy's largest bank. Investors should favor shorter-dated notes and two-year gilt yields may drop to 4 percent by year-end, he predicted.

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