July 11 (Bloomberg) -- The pound fell against the dollar for a second week as U.K. stocks fell to their lowest in more than two months on indications Europe’s second-largest economy remains mired in a recession.

The British currency also recorded its biggest weekly loss against the yen in more than five months. The FTSE 100 Index slid 0.8 percent yesterday as a report showed producer prices dropped in June by the most since 2001. The price of goods leaving factories fell an annual 1.2 percent, the Office for National Statistics said. Economists predicted a 0.8 percent drop, according to the median of 19 forecasts in a Bloomberg survey.

“Producer prices are sterling negative and it’s adding to the overall picture,” said Ian Stannard, a currency strategist at BNP Paribas SA in London.

The British currency fell to $1.6207 as of 6:10 p.m. yesterday in London, leaving it 0.8 percent lower in the week. It tumbled 4.6 percent this week to 149.62 yen, its fourth weekly drop. Sterling capped its third weekly loss after falling to 86.19 pence per euro.

After climbing almost 13 percent against the dollar in the first half of the year, the pound is sliding as investors pare back expectations for a revival in the U.K. economy. The Organization for Economic Cooperation and Development said on June 24 that U.K. gross domestic product will shrink 4.3 percent this year, revising its March forecast for a 3.7 percent contraction. Sterling has fallen 1 percent in the past month.

‘Reassessing Sterling’

“The market is reassessing sterling’s ability to rally over the next quarter,” said Jane Foley, research director in London at Forex.com, an online currency trader.

Gilts rose yesterday, with the two-year security posting a weekly advance, as investors sought refuge in the relative safety of fixed-income assets. The 10-year note dropped in the week after the Bank of England said it will scale back its bond- buying program at the end of July to assess its success.

The central bank plans to purchase 4.5 billion pounds of gilts as part of its asset-purchase facility next week. At the same time, bond issuance will ease, with the Treasury scheduled to hold one “mini tender” of 2032 notes.

“There is a certain amount of risk aversion but we’re also entering a period of relatively light supply,” said Adam McCormack, head of gilt sales at Barclays Capital in London. “Buybacks, although smaller, are continuing.”

Program Review

The yield on the two-year security dropped 9 basis points to 1.18 percent, leaving it 15 basis points lower in the week. The 4.25 percent security due March 2011 rose 0.13, or 1.3 pounds per 1,000-pound face amount, to 105.18. The yield on the 10-year gilt dropped 5 basis points to 3.73 percent, little changed on the week.

Gilts tumbled two days ago after policy makers decided against expanding the 125 billion-pound bond-buying program. The central bank “will review the scale of the program again at its August meeting,” it said in a statement.

The U.K. government authorized the bank to spend a total of 150 billion pounds to purchase assets. Were the Monetary Policy Committee to decide to print more money to fund the plan, it would have to ask for Chancellor of the Exchequer Alistair Darling’s permission.

The central bank’s quantitative easing plan helped support bonds at a time when government debt sales across the world threatened to overwhelm investor demand. Gordon Brown’s government plans to sell an unprecedented 220 billion pounds of securities this fiscal year as it seeks to fund bailouts and economic-stimulus measures.

U.K. government bonds returned 0.1 percent in the week through yesterday, compared with a 0.4 percent gain for U.S. debt and 0.2 percent for German bunds, according to Merrill Lynch & Co.’s U.K. Gilts, U.S. Treasury Master and German Federal Governments indexes.

To contact the reporter on this story: Anna Rascouet in London at arascouet@bloomberg.net

Last Updated: July 11, 2009 02:30 EDT