U.K. Pound Declines Against Euro as Retail Sales Growth Slows

By Lukanyo Mnyanda and Andrew MacAskill

Aug. 21 (Bloomberg) -- The U.K. pound fell against the euro after a government report showed retail sales rose by the weakest annual rate in 17 months in July, strengthening the case for lower interest rates.

The U.K. currency briefly rallied after the Office for National Statistics said sales unexpectedly rose in the month. The gain on the year was the smallest since February 2006 and added to evidence the economy is headed for a recession. The pound fell yesterday after the minutes of the Bank of England's August rates meeting yesterday showed policy makers judged inflation risks ``have probably eased a little.''

``There are still a lot of worries ahead,'' said Paul Bednarczyk, a currency strategist in London at 4Cast Ltd., a research company that counts central banks among its subscribers. ``I don't think there is much upside for sterling until all the data is out the way.''

Against the single European currency, the pound dropped 0.1 percent to 79.37 pence by 12:25 p.m., from 79.21 yesterday and 79.07 pence earlier. It traded at $1.8628, after earlier posting its biggest gain since Aug. 14, to $1.8702. It slipped to $1.8512 on Aug. 15, the lowest level since July 2006. The pound will probably fall to $1.83 by year-end, Bednarczyk said.

Deutsche Bank AG changed its U.K. interest-rate forecast today and said the Bank of England will lower borrowing costs by 1 percentage point next year. The benchmark rate will be cut to 4 percent in the first three quarters of 2009, George Buckley, the bank's chief U.K. economist, wrote in an e-mailed note.

Gilts Slip

Gilts rose, with the yield on the 10-year bond falling 1 basis point to 4.54 percent. The price of the 5 percent security due March 2018 declined 0.09, or 90 pence per 1,000-pound face amount, to 103.49. The yield on the two-year gilt, which is more sensitive to the outlook for interest rates, slipped 1 basis point to 4.53 percent. Bond yields move inversely to prices.

Sales gained 0.8 percent in July, compared with the 0.2 percent drop forecast by economists in a Bloomberg survey, a statistics office report showed today. The growth rate dropped to an annual 2.1 percent from 2.2 percent in June and 8.1 percent in May.

The spread between U.K. government bonds and their German counterparts has narrowed as traders bet the end of a decade-long rally in the nation's housing market will prompt a reduction in borrowing costs. The 10-year gilt yielded 40 basis points more than the German bund, down from 69 basis points on Feb. 25, the widest this year.

U.K. bonds have outperformed their European counterparts in the past three months as evidence the economic slowdown is deepening persuaded investors to remove wagers on rate increases. The implied yield on the March short-sterling futures contract was at 5.21 percent, from 5.44 percent at the end of July.

The nation's bonds have returned 4.4 percent since the past two months, compared with 3.2 percent from their European counterparts, according to Merrill Lynch & Co.'s EMU Direct Government and U.K. Gilts Master indexes.

To contact the reporters on this story: Lukanyo Mnyanda in London at lmnyanda@bloomberg.net; Andrew MacAskill in London at amacaskill@bloomberg.net