U.K. Pound Declines Against Euro Before Retail Sales Report

By Lukanyo Mnyanda

Aug. 21 (Bloomberg) -- The U.K. pound fell against the euro for a fourth day and traded near a two-year low versus the dollar before a government report that may show retail sales fell last month, adding to evidence the economy is headed for a recession.

Retail sales probably fell 0.2 percent in July, after dropping in June by the most since at least 1986, a survey of economists by Bloomberg News showed. The currency dropped yesterday after the minutes of the Bank of England's August policy meeting showed policy makers judged inflation risks ``have probably eased a little'' in the past month, prompting traders to reduce wagers on higher interest rates.

``The principle driver for sterling is the interest rates dynamic,'' Adam Cole, head of global currency strategy at RBC Capital Markets, part of Royal Bank of Canada, said in a Bloomberg Television interview. ``We think the Monetary Policy Committee will cut rates in November.''

The pound was at 79.35 pence per euro by 6:59 a.m. in London, from 79.21 yesterday in New York. The currency was little changed at $1.8636. It slipped to $1.8512 on Aug. 15, the lowest level since July 2006.

Minutes of the Bank of England's Aug. 7 policy meeting showed seven rate-setters, including Governor Mervyn King, voted to keep the benchmark rate unchanged at 5 percent. Timothy Besley backed an increase, while David Blanchflower favored a reduction.

``The outlook for activity growth had continued to worsen'' and ``some measures of inflation expectations had fallen back in July,'' according to the minutes.

Economic Slowdown

The pound lost 3 percent against the dollar last week, its biggest five-day drop since the period through July 1, 2005, as traders bet falling house prices will exacerbate the economic slowdown.

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 44 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 5.16 percent yesterday, from 5.44 percent at the end of July.

The nation's bonds have returned 4.2 percent since the end of June, compared with 3.5 percent from their European counterparts, according to Merrill Lynch & Co.'s EMU Direct Government and U.K. Gilts Master indexes.

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