U.K. Pound Falls Against Dollar, Euro as Retail Sales Decline

By Lukanyo Mnyanda

Nov. 20 (Bloomberg) -- The U.K. pound dropped and government bonds rose after retail sales fell for a second month, raising the likelihood policy makers will cut borrowing costs to revive Britain’s faltering economy.

The currency declined the most in a week versus the euro as the Office for National Statistics said sales shrank 0.1 percent last month. The Bank of England signaled yesterday it’s prepared to cut interest rates further, after reducing the main rate 1.5 percentage points to the lowest level since 1955.

“The economic outlook is still negative for the pound,” said Antje Praefcke, a currency strategist in Frankfurt at Commerzbank AG, Germany’s second-biggest lender. “The huge rate cuts and bad fundamentals are considerably negative.”

The pound fell to $1.4896 as of 1:06 p.m. in London, from $1.4952 yesterday, when it reached the highest level since Nov. 12. The U.K. currency is down 25 percent against the dollar this year. Against the euro, it weakened to 84.22 pence from 83.55 pence. It reached a record low of 86.63 pence last week.

Central banks around the world are discussing deeper reductions in borrowing costs as economies founder. Federal Reserve policy makers predicted the U.S. will contract through mid-2009, with some prepared to cut rates further, a record of their latest meeting showed yesterday. The Swiss National Bank cut its key rate 100 basis points to 1 percent today.

The pound may drop to $1.45 against the dollar in the “next couple of days,” said Praefcke, who also recommends investors sell it against the Japanese yen as global growth slows. The pound lost 0.5 percent to 142.42 yen today.

Bigger Cut Considered

U.K. policy makers, led by Governor Mervyn King, considered a bigger reduction in the key interest rate on Nov. 6, according to minutes of their meeting released yesterday. The monetary policy committee discussed the need for a cut to less than 2.5 percent, the minutes showed. It settled on 3 percent.

The yield on the 10-year gilt slipped below 4 percent for the first time since January 2006, falling seven basis points to 3.97 percent. The 5 percent security due March 2018 advanced 0.57, or 5.7 pounds per 1,000-pound ($1,484) face amount, to 107.91. The yield on the two-year note decreased nine basis points to 2.06 percent, near the lowest level since at least 1992. Yields move inversely to bond prices.

“The front-end should perform quite well,” Andre de Silva, global deputy head of fixed-income strategy in London at HSBC Holdings Plc, Europe’s biggest bank by market value, said in a Bloomberg Television interview. “We have seen the MPC cut early and boldly.”

Sale Demand Drops

Investors increased bets the Bank of England will cut rates again. The implied yield on the short-sterling December futures contract dropped seven basis points to 3.37 percent today, bringing its decline since Oct. 31 to 87 basis points.

Policy makers “will do whatever to ensure that inflation remains close to our target,” Bank of England Chief Economist Spencer Dale said in an interview published in the Newcastle Journal today.

The decline in retail sales was less than the 0.9 percent median forecast in a Bloomberg News survey of 27 economists. Household goods stores led the monthly drop as shoppers bought fewer electrical items, the statistics office said.

Demand dropped today at a sale of 3 billion pounds of 4.50 percent government notes maturing in March 2019. Investors bid for 1.6 times the securities offered, down from 2.19 times at the auction of the same bonds on Sept. 25. The yield averaged 4.14 percent.

Surging Borrowing

“The result was pretty weak,” said John Wraith, head of U.K. rates-product development at Royal Bank of Canada in London. “The big build-up in supply means you need higher yields, but that has been masked by the slowing economy.”

Government borrowing is surging as the looming economic recession cuts tax revenue. The U.K. budget deficit swelled to 37 billion pounds in the first seven months of the year, the largest since records began in 1993, the Office for National Statistics said today.

British government bonds still rallied this month as investors’ inflation expectations fell, with the U.K.’s five- year breakeven rate dropping below zero for the first time this week. The conventional gilt yielded 20 basis points less than its inflation-protected counterpart today.

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