British Pound Rises Against Euro; Rate Cuts May Revive Growth

By Matthew Brown and Gavin Finch

Jan. 6 (Bloomberg) -- The pound rose against the euro for a second day, trading close to 91 pence for the first time in almost three weeks, on speculation interest-rate cuts will revive the economy faster than in the common-currency region.

The British currency also gained versus the yen and the Swiss franc as the FTSE 100 index of leading U.K. shares climbed for a sixth day. Debenhams Plc, Britain’s second-largest department-store company, increased the most in more than 2 1/2 years in London trading after saying a decline in sales eased.

“Oversold sterling is getting a bit of a bounce,” said Jeremy Stretch, a senior currency strategist at Rabobank International in London. “The markets are waking up and realizing that the eurozone garden is not particularly rosy.”

The pound advanced 1.5 percent against the euro to 91.40 pence as of 12:02 p.m. in London, adding to yesterday’s 3.2 percent gain, which was the largest since the creation of the single currency in 1999.

The pound slid 23 percent against the European currency last year, its biggest decline since the euro came into existence, as the Bank of England cut rates faster than the European Central Bank and the British economy entered its first recession in 17 years.

Europe’s inflation rate fell 0.5 percentage point to 1.6 percent in December, the lowest in more than two years as oil prices plunged and consumer spending slumped, increasing the scope for the ECB to reduce borrowing costs further.

Recession Deepens

The region’s manufacturing and service industries contracted for a seventh month in December as the economy slid deeper into a recession. A composite index of both industries dropped to 38.2, the lowest since the survey began in 1998, from 38.9 in November.

The pound may still fall to parity with the euro as the Bank of England cuts interest rates at a quicker pace than the European Central Bank does, according to Richard McGuire, a senior fixed-income strategist in London at Royal Bank of Canada, the country’s biggest lender.

“We think U.K. rates will fall to 0.5 percent as early as next month, which should weigh on the pound,” McGuire said. “Meanwhile the ECB is expected to pursue a comparatively gradualist approach to policy easing.”

U.K. services from restaurants to airlines shrank at close to the fastest pace in at least a dozen years and house prices fell by the most since 1991, data indicated today, suggesting that the recession is intensifying.

‘Flight to Quality’

An index based on a survey of about 700 service companies by the Chartered Institute of Purchasing and Supply was at 40.2 in December, compared with November’s 40.1, which was the lowest since the gauge began in 1996, Markit said today. The average price of a home fell an annual 15.9 percent in December, Nationwide Building Society said in a separate report.

U.K. government bonds fell, pushing the yield on the 10-year gilt up four basis points to 3.19. The 5 percent security due March 2018 fell 0.34, or 3.0 pounds per 1,000 pounds ($1,462) face amount, to 114.28. The two-year gilt yield fell five basis points to 1.78 percent.

“We have very serious doubts over whether this will amount to anything more than a short term pause in the ongoing flight to quality as the global economy continues to unravel,” said John Wraith, head of sterling rate product development at Royal Bank of Canada in London. “With yields having fallen so far in such a short space of time over recent months, the correction could easily go a lot further over the days ahead without threatening any medium term chart patterns.”

To contact the reporter on this story: Matthew Brown in London at mbrown42@bloomberg.net; Gavin Finch in London at gfinch@bloomberg.net;