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Pound Gains on Speculation Economic Expansion May Lead to Rate Increase

The pound rose and gilts fell after reports predicting faster economic growth and a narrower-than- forecast budget deficit spurred speculation the Bank of England will have to raise interest rates.

Sterling advanced to a one-month high versus the dollar after policy maker Andrew Sentance said officials face “interesting debates” in the second half of 2010 on how long to keep up stimulus. The Confederation of British Industry, the U.K.’s biggest business lobby, raised its forecast for gross domestic product. The Office for Budget Responsibility said the deficit will narrow to 71 billion pounds ($105 billion) by April 2015, from 155 billion pounds this fiscal year.

“We’re getting increasingly positive comments,” said Neil Mellor, a currency strategist at Bank of New York Mellon Corp. in London. “Sovereign risk has clearly been a driver of risk retreat and there’s a relief to some extent that lawmakers are getting on with” tackling the U.K. budget deficit, he said.

The pound rose 1.5 percent to $1.4765 as of 5:10 p.m. in London after reaching $1.4809, the highest level since May 13. It was 0.1 percent stronger at 83.18 pence per euro. Sterling advanced against all but two of its 16 most-traded peers.

The yield on the short-sterling futures contract for March 2011 rose eight basis points to 1.22 percent as investors added to bets policy makers will increase the key rate, which is at an all-time low of 0.5 percent.

Interest Rates

Bank of England policy makers last week kept the key rate at a record low for a 16th month and held a bond-purchase program at 200 billion pounds, even as inflation exceeds the government’s 3 percent upper limit.

Inflation reached a 17-month high of 3.7 percent in April. The Office for National Statistics may say tomorrow that consumer-price growth was 3.5 percent in May, according to the median of 30 forecasts in a Bloomberg survey.

“Surveys point to some upward pressure on public inflation expectations,” Sentance wrote in an article published yesterday in the Sunday Times. “There also appears to be less spare capacity in the economy than many had feared.”

Gross domestic product will rise 1.3 percent this year, compared with a prediction in March of 1 percent, the CBI said in an e-mailed press release. That’s because a drop in the pound is helping manufacturers to increase exports. The group kept its 2011 forecast unchanged at 2.5 percent growth.

“The U.K. economy continues to emerge from the effects of the financial crisis,” Bank of England Chief Economist Spencer Dale said in the central bank’s quarterly bulletin published today. “That recovery is likely to gather pace over the next year.”

Budget Day

Sterling fell 8.7 percent this year against the dollar amid speculation the central bank will keep rates at a record low as lawmakers tackle its record budget deficit. Chancellor of the Exchequer George Osborne is set to outline spending cuts in an emergency budget on June 22. Fitch Ratings said last week that Prime Minister David Cameron’s coalition needs to step up the pace of reductions to protect Britain’s top credit rating.

The OBR, set up by the new government, said today GDP will rise 2.6 percent next year, less than the 3.25 percent predicted by the Labour government in March.

“The report is slightly more positive about the U.K.’s prospects than was expected,” boosting the pound, said Paul Robinson, a currency strategist at Barclays Capital in London.

Stocks Gain

OBR head Alan Budd said in a press conference in London today there was a 50 percent probability of the budget deficit falling below 4 percent of gross domestic product in 2014-2015. The budget office will release revised forecasts on June 22 to take account of the measures announced by Osborne.

The yield on the 10-year gilt increased seven basis points to 3.54 percent and the two-year note yield advanced nine basis points to 0.9 percent.

“Stocks are extending last week’s gains and that’s taking the shine off government bonds,” said Nick Stamenkovic, a fixed-income strategist in Edinburgh at RIA Capital Markets Ltd., a broker for banks and investors.

The FTSE 100 Index of shares rose 0.7 percent, after a 0.7 percent gain last week.

To contact the reporter on this story: Paul Dobson in London at pdobson2@bloomberg.net

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