Pound Rises, Gilts Fall as Inflation Accelerates at Record Pace

By Anchalee Worrachate

Jan. 19 (Bloomberg) -- The pound rose to a four-month high against the euro and two-year gilt yields jumped the most since November as a report showed the biggest increase on record in the U.K. inflation rate, stoking speculation borrowing costs may increase soon.

The pound climbed against all 16 major currencies tracked by Bloomberg, while the 10-year breakeven rate, a market gauge of inflation expectations, rose to the most since October 2008. December consumer prices advanced 2.9 percent from a year earlier, one full percentage point more than in November, according to the Office for National Statistics.

“The CPI number is a shocker,” said Peter Schaffrik, a co-head of interest rate strategy in London at Commerzbank AG. “It means the Bank of England will have to rein in its monetary stimulus, perhaps sooner rather than later. We are avoiding gilts, especially at the front end. It’s difficult for the market to outperform others against this backdrop.”

The pound traded at 87.37 pence per euro as of 11:34 a.m. in London from 88.03 pence yesterday. It strengthened below 88 pence for the first time since Sept. 15 yesterday. The pound traded at $1.6377 after rising to $1.6458 earlier, the highest since Dec. 8.

Britain’s economy is showing signs of recovery from its longest recession on record after the Bank of England cut its key interest rate to an all-time low of 0.5 percent and embarked on a 200 billion-pound ($328 billion) program of asset purchases. A survey yesterday showed asking prices for homes in England and Wales increased in January.

The pound was also boosted as Kraft Foods Inc. said it’s near an agreement to buy Cadbury Plc after four months of wrangling with the U.K. confectioner over price.

Gilt Spread

“Economic data are starting to look more encouraging,” said Neil Jones, head of European hedge-fund sales in London at Mizuho Corporate Bank Ltd. “The Kraft-Cadbury news is also supportive for the pound. Foreign money is coming in to buy U.K. assets, which have become cheap.”

The yield on U.K. short-sterling interest-rate futures contract expiring in December 2010 climbed 12 basis points to 1.78 percent as traders added to bets that the Bank of England will increase borrowing costs this year.

The consumer-price report was the first since May showing inflation above the central bank’s 2 percent target, presenting a challenge as policy makers assess when to start raising borrowing costs. Prime Minister Gordon Brown, who faces an election by June, is confident the economy has returned to growth, a spokesman said last week.

Falling Gilts

Gilts declined, pushing the yield on the 2-year note up 15 basis points, the biggest one-day increase since Nov. 12, before standing 9 basis points higher on the day at 1.30 percent. The 3.25 percent security due December, 2011 fell 0.18, or 1.8 pounds per 1,000-pound face amount, to 103.61. The 10-year yield rose 8 basis points to 4.02 percent.

The yield difference between 10-year gilts and index-linked debt, known as the breakeven rate, rose to 3.05 percentage points, the most since October 2008.

The yield gap between two- and 10-year notes was little changed at 2.71 percentage points. It earlier narrowed by 4 basis points to 2.68 percentage points, the least since Jan. 4.

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