Dec. 5 (Bloomberg) -- The pound posted a weekly drop against the euro and the dollar and 10-year government bonds rose by the most in a decade after the Bank of England cut its key interest rate yesterday to the lowest level since 1951.

The pound, which strengthened today versus the euro, slid to a record low against the currency yesterday, and weakened against all but one of its 16 most-actively traded peers this week. Policy makers lowered their main rate by 1 percentage point to 2 percent as the global financial crisis pushed the British economy into a recession.

“The path of least resistance is for the pound to fall further,” said Russell Jones, London-based head of global fixed income and currencies at RBC Capital Markets. “It’s most likely that policy makers will need to do more. Interest rates may need to go to zero.” Jones said he favors the dollar and the Japanese yen to sterling.

The pound strengthened to 86.74 pence per euro as of 6:10 p.m. in London, trimming its weekly drop to 4.9 percent. It earlier lost 5.5 percent in the five days, the most since the debut of the European common currency in 1999. Against the dollar, the pound was at $1.4606, from $1.4680, for a weekly decline of 5 percent, the most since the period ended Nov. 14.

U.K. government bonds rose, with 10-year gilts logging the biggest weekly gain since Oct. 2, 1998. The yield on the 10-year gilt fell four basis points to 3.42 percent, extending the five- day decline to 35 basis points. The 5 percent security due March 2018 rose 0.31, or 3.1 pounds per 1,000-pound ($1,460) face amount, to 112.41.

Jobs Report

Bonds were underpinned by a report showing U.S. employers cut jobs in November at the fastest pace in 34 years and the unemployment rate jumped as the yearlong recession in the world’s largest economy worsened. Payrolls shrank by 533,000 workers last month, the most since 1974, after falling a revised 320,000 the prior month, the Labor Department said today.

U.K. gross domestic product shrank by 0.5 percent in the third quarter, the first drop in 16 years. The economy may contract 1.1 percent next year, the most since 1991, the Organization for Economic Cooperation and Development said Nov. 25. Home values declined 2.6 percent in November, the biggest drop since 1992, and 16.1 percent from a year earlier, HBOS Plc, Britain’s biggest mortgage lender, said this week.

The Bank of England will cut its key interest rate to 1.25 percent by September, according to economists in a Bloomberg survey.

‘Challenging Quarter’

Two-year notes erased gains as the Debt Management Office announced it will hold a record 20 sales of gilts in the next quarter as the government seeks to raise cash to offset a slump in tax revenue.

The yield on the two-year gilt rose three basis points to 1.85 percent, after falling to as low as 1.71 percent, and sliding 36 basis points in the week. Yields move inversely to bond prices.

“This is the most challenging quarterly calendar to date in terms of the number of operations,” DMO Chief Executive Robert Stheeman said in a statement.

The sales are part of the 146.4 billion pounds of gilts Prime Minister Gordon Brown’s government aims to sell in the fiscal year that started April 1. The amount, an all-time high, is 83 percent more than the 80 billion pounds the government originally estimated it would issue in March.

Pimco’s View

Further declines by the pound may be limited, according to money managers. Pacific Investment Management Co., which said as recently as September the pound was “overvalued,” and Millennium Asset Management exited or cut bets the currency will weaken after a series of rate cuts by the Bank of England.

“If you were shorting the pound, now is the time to reduce those positions,” said Myles Bradshaw, a money manager in London at Pimco, manager of the world’s largest bond fund. “The arguments to be underweight are not as strong anymore.”

Policy makers said after cutting interest rates yesterday that the slide in the pound “raised the profile” of inflation.

The yield gap between two- and 10-year notes widened to 158 basis points from 156 basis points last week. The so-called steeper yield curve suggested investors raised bets the economy will worsen and that the central bank will reduce borrowing costs further.

Gilts outperformed U.S. Treasuries and European bonds this quarter. U.K. government bonds handed investors an almost 8 percent return since the end of September, compared with a gain of 7.4 percent from Treasuries and 7.30 percent from German bonds, according to Merrill Lynch & Co.’s U.K. Gilts, U.S. Treasury Master and German Federal Government indexes.

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

Last Updated: December 5, 2008 13:46 EST