Gilts Rise, Pound Set for Weekly Decline, on Recession Concern

By Agnes Lovasz

Nov. 7 (Bloomberg) -- U.K. government bonds rose and the pound headed for its biggest weekly drop versus the euro since December 2004 as yesterday's bigger-than-forecast interest-rate cut by the Bank of England stoked concern about the depth of Britain's economic slump.

Two-year gilts were set for a third weekly gain, with yields down more than 1 percentage point in that period. Policy makers, led by Governor Mervyn King, reduced the benchmark rate to 3 percent yesterday, the lowest level since 1955. Traders raised bets more cuts will follow, interest-rate futures show.

``Continuing weak fundamentals will not yet allow the pound to recover,'' said Antje Praefcke, a currency strategist in Frankfurt at Commerzbank AG. ``Despite yesterday's decision, we believe that the Monetary Policy Committee will go for further interest-rate cuts.''

The pound traded at 81.23 pence per euro by 12:10 p.m. in London, from 81.38 pence yesterday, and was down 2.4 percent in the week. It climbed to $1.5723, from $1.5627, trimming a weekly decline to 2.2 percent.

Monetary policy is being eased because the 15-month credit crisis is inflicting harsher blows to growth and inflation than central bankers anticipated. The International Monetary Fund yesterday cut its month-old forecast for global expansion in 2009 to 2.2 percent from 3 percent. The U.K. economy will contract 1 percent, the European Commission predicted Nov. 3.

Reports this week showed U.K. services shrank in October and factory production had its longest streak of declines for almost three decades. Production slid 0.8 percent from August, the biggest drop in 19 months.

Bonds Climb

The European Central Bank lowered its main rate by half a percentage point to 3.25 percent, its second cut in less than a month. ECB President Jean-Claude Trichet declined to rule out further reductions.

U.K. government notes rose, with the yield on the two-year gilt dropping 5 basis points to 2.50 percent, from 2.93 percent at the end of last week. The 4.75 percent security due June 2010 climbed for an eighth day, its longest run of gains in a year, adding 0.03, or 30 pence per 1,000 pound ($1,576) face amount, to 103.43. The 10-year yield dropped 10 basis points to 4.23 percent, down from 4.52 percent on Oct. 31.

The implied yield on the December short-sterling futures contract fell 13 basis points to 3.56 percent, after dropping 44 basis points yesterday, indicating traders increased bets for more rate reductions.

To contact the reporter on this story: Agnes Lovasz in London at alovasz@bloomberg.net