Pound Posts Biggest Weekly Gain Versus Dollar in Almost 3 Years

By Anchalee Worrachate

Nov. 29 (Bloomberg) -- The pound had its biggest weekly advance against the dollar in almost three years as a rebound in stocks rekindled appetite for higher-yielding currencies.

The U.K. currency also rose for a second straight week against the euro as the FTSE 100 Index advanced the most this week in nearly a month. The pound lost 3.4 percent against the dollar and 3.5 percent against the euro in November on speculation that a recession in Britain will deepen, forcing the Bank of England to cut interest rates at a faster pace than the Federal Reserve and European Central Bank.

“The rebound in equity markets provided some support for sterling in the near term and I wouldn’t rule out it pressing higher in coming days,” said Ian Stannard, a foreign-exchange strategist at BNP Paribas SA in London. “Longer term though, I still believe sterling is vulnerable. We expect its recent rally to run out of steam in the middle of next week. The economic outlook will continue to weigh on the currency.”

The pound dropped to $1.5333 yesterday in London, from $1.5406 on Nov. 27. It rose 2.6 percent in the past week, the most since Jan. 6, 2006. The currency strengthened 1.9 percent from the previous week to 82.83 pence per euro. The pound will fall to $1.41 by year-end, BNP Paribas said.

The pound has a correlation of 0.72 with the MSCI World Index in the past 12 months, according to Bloomberg data. A value of 1 would mean the two move in lockstep.

The seizure in credit markets and an approaching recession sapped consumer demand in Europe’s second-largest economy, prompting the Bank of England to cut its key interest rate four times this year from 5.50 percent. Policy makers this month reduced the key interest rate by 150 basis points to 3 percent, the lowest since 1955. The pound dropped 4.5 percent against both the dollar and 4.3 percent versus the euro in November.

Gilts Rise

U.K. gilts rose yesterday as investors sought the relative safety of government bonds, with two-year notes snapping four days of losses.

The gains pushed the yield 15 basis points lower to 2.19 percent. The 4.75 percent due June 2010 climbed 0.21, or 2.1 pounds per 1,000-pound ($1,536) face amount, to 103.81. The yield on the 10-year note dropped one basis point to 3.77 percent. The yield dropped 11 basis points this week. Yields move inversely to bond prices.

The “big issue” for the British economy is to get banks to lend again, Timothy Besley, a member of the Bank of England’s Monetary Policy Committee, said Nov. 27. The central bank’s next interest-rate decision is due Dec. 4.

Policy makers will cut the main interest rate at least another 75 basis points to 2.25 percent next week, according to a Credit Suisse Group AG index of probability based on overnight index-swap rates.

Gilts Versus Bunds

“If that’s the market consensus, then the two-year yield at the current level is a steal,” said Jason Simpson, a fixed- income strategist at Royal Bank of Scotland Group Plc in London. “The market is expecting aggressive rate cuts ahead and that should support the front end of the market.”

Gilts beat their European counterparts this past month, handing investors a 5 percent return, compared with a gain of 3.8 percent on German bonds, according to Merrill Lynch & Co. U.K. Gilts and German Federal Governments indexes.

The looming recession in the U.K. caused investors to raise bets on deflation in the past month. The five-year breakeven rate, a gauge of inflation expectations as measured by the difference in yield between regular bonds and index-linked debt, was minus 91 basis points yesterday, compared with a positive 105 basis points at the start of November.

The economic pessimism is “overdone,” leaving the securities at “attractive levels,” Steve Major, HSBC Holdings Plc’s head of fixed-income strategy in London, wrote in a note to clients received by e-mail Nov. 27. “At some stage, the market will look beyond the deflation discounted for 2009 and to the risks of rising inflation by 2010-11.”

To contact the reporter on this story: Anchalee Worrachate in London at aworrachate@bloomberg.net