Pound Weakens Versus Euro as BOE Holds Rates, ECB Signals Inflation Alert

The pound fell the most this year versus the euro amid optimism Europe’s debt crisis is abating after European Central Bank President Jean-Claude Trichet signaled he’d raise interest rates if needed to fight inflation.

Sterling also weakened against the common currency after the Bank of England kept its key interest rate at a record low and left its bond-purchase program unchanged. The U.K. currency was at its strongest in more than a month against the dollar after U.S. data showed initial jobless claims rose.

“Trichet took this inflation fighting stance that really fuelled euro-sterling and also euro-dollar,” said John Hydeskov, senior foreign-exchange analyst at Danske Bank A/S in London. “He was substantially more hawkish than markets expected.”

The pound depreciated 1.1 percent to 84.25 pence per euro as of 5:22 p.m. in London, after reaching 84.27 pence, its steepest intraday decline since Dec. 30. Sterling was 0.7 percent stronger at $1.5875. Earlier it rose to $1.5884, the strongest level since Dec. 14 when it reached $1.5911.

Trichet told a press conference in Frankfurt that the European Central Bank is “permanently alert” on interest rates. At the same time, the benchmark rate, which the ECB left at 1 percent, is still “appropriate.”

His comments and successful bond auctions from Portugal and Spain pushed the British currency weaker for the fourth straight day against the euro.

Bond Auctions

Demand rose at a Spanish bond auction today with investors bidding for 2.1 times the securities on offer, up from 1.6 times last time the debt was sold. Spain sold 3 billion euros ($3.9 billion) of five-year bonds.

“Auctions are going well,” said Peter Frank, a currency strategist at Societe Generale SA in London. He said the better news from the euro-region was causing the single currency to rally across the board.

The U.K. central bank kept its so-called quantitative- easing program unchanged at 200 billion pounds and its key rate at 0.5 percent, as predicted by economists in Bloomberg surveys.

Bank of England officials have split three ways in the past three months on whether to focus on risks to growth or rising prices. U.K. inflation accelerated to 3.3 percent in November from 3.2 percent in October, data last month showed, remaining above the government’s 3 percent limit for a ninth month.

Details of today’s decision will be released Jan. 26, when minutes of the two-day meeting are published.

U.K. government bonds stayed higher after the decision, with the 10-year gilt yield five basis points lower at 3.60 percent, and two-year yields down four basis points to 1.31 percent.

Short Sterling

The implied yield on short-sterling futures contracts for September 2011, which anticipates where short-term interest rates will be, fell for the first day in five today, as traders reduced bets for higher borrowing costs. The yield was at 1.32 percent, up from 1.05 percent at the beginning of the year, as traders anticipated rising consumer prices will push the central bank to raise its key rate sooner than previously predicted.

Economists forecast the benchmark rate will rise to 0.75 percent in the third quarter from 0.50 percent today, according to a Bloomberg survey. Last week, the same survey predicted the rate would rise in the fourth quarter.

“Inflation has been elevated for longer than the Bank of England ever expected and is likely to remain that way for some time to come,” said Michael Derks, head of currency strategy at FXPro Financial in London. He predicts the central bank will increase its key rate at one of the policy makers’ next three meetings, causing the pound to strengthen.

Data today showed U.K. manufacturing strengthened more than economists forecast in November, a sign the recovery maintained some momentum in the final quarter of last year.

Factory output rose 0.6 percent from October, when it also increased at the same pace, the Office for National Statistics said today in London. That’s the seventh consecutive monthly increase. The median forecast of 23 economists in a Bloomberg News survey was for an increase of 0.4 percent. Overall industrial output rose 0.4 percent in November.

To contact the reporter on this story: Emma Charlton in London at echarlton1@bloomberg.net

To contact the editor responsible for this story: Daniel Tilles at dtilles@bloomberg.net

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