U.K. Bonds Rise; Two-Year Yield Drops Below 1% on Bets BOE to Hold Rates

U.K. government bonds rose and the pound fell to the lowest in more than a year versus the euro after worsening economic data spurred speculation the Bank of England will keep rates at a record low to revive growth.

Yields on two-year notes slipped below 1 percent for the first time in five months while the pound traded weaker than 90 pence per euro for a second straight day. House prices declined for the first time in three months while a gauge of construction growth unexpectedly dropped to a four-month low.

“Gilts still offer reasonable value over the medium term,” said Elisabeth Afseth, an analyst at Evolution Securities Ltd. in London. “Any rate move is likely to be after the summer rather than before -- you’re still looking at a fairly fragile economy.”

The yield on the 10-year gilt fell four basis points to 3.38 percent as of 4:27 p.m. in London, the least since Dec. 6. Two-year notes due March 2013 yielded 1.02 percent after sliding below 1 percent for the first time since Dec. 8.

The pound depreciated as much as 0.4 percent to 90.29 pence per euro, its weakest level since March 29, 2010, before trading at 89.91. Sterling climbed 0.3 percent to $1.6530.

Worsening economic data may ease pressure on the Bank of England to raise rates to curb inflation, which has soared to more than twice the central bank’s 2 percent target. Policy makers will keep the key rate at 0.5 percent when they announce their next decision tomorrow, according to a Bloomberg survey.

Home Prices

The average cost of a British home dropped 0.2 percent from March to 165,609 pounds ($273,000), Nationwide Building Society said, compared with a gain of 0.1 percent forecast in a Bloomberg survey of 14 economists. That’s the first decrease since January.

A gauge of building activity based on a survey of purchasing managers fell to 53.3 in April, from 56.4 the previous month, Markit Economics Ltd. and the Chartered Institute of Purchasing and Supply said. That was below the 55.9 estimate in a Bloomberg survey and the lowest since December.

“Rate hike expectations are being pushed back,” said Stephen Gallo, head of market analysis at Schneider Foreign Exchange in London. “That’s weighing on sterling.”

S&P dissented from that view today, saying it expects rates to rise within three months as inflation resumes its surge. U.K. inflation unexpectedly eased to 4 percent in March after five months of acceleration brought the rate to 4.4 percent in February. That level was the highest in more than two years and more than twice the central bank’s 2 percent limit.

Inflation Peak

“A first rate hike seems almost certain in the coming three months,” S&P’s chief economist for Europe, Jean-Michel Six, said in today’s report. “After the March blip, we think inflation is likely to take off once again, to peak around 5 percent in the third quarter.”

Short-sterling futures fell, lifting the implied yield on the contract expiring March 2012 by one basis point to 1.26 percent, as investors added to bets for interest-rate increases next year.

The U.K.’s benchmark rate compares with 1.25 percent in the euro region, boosting the yield allure of the shared European currency against its British counterpart. The European Central Bank raised its main rate by a quarter point last month and left the door open for further increases to curb inflation, which is accelerating at the fastest pace in 2 1/2 years.

Rate Prospects

“Rates will probably go up towards the end of the year but they aren’t going to go up to anywhere near historical averages for a while,” said Afseth. “There might be some short-term volatility in yields once rate hikes begin, but there’s no reason for them to move up too quickly just yet.”

The ECB is expected to leave the rate unchanged when it meets tomorrow according to all 48 analysts polled by Bloomberg.

A measure of the pound against its nine most traded peers fell to 60.70 as measured by Bloomberg Correlation-Weighted Currency Indexes. That’s near the 60.63 level reached yesterday, which was the lowest since records began in 1975.

Separate data this morning showed U.K. mortgage approvals were little changed in March as a squeeze on incomes weighed on the housing market. Lenders granted 47,557 home loans, up from a revised 46,708 in February, the Bank of England said. The median forecast of 11 economists in a Bloomberg survey was for an increase to 48,000 from an initially reported 47,000. Net mortgage lending rose 400 million pounds in March, half the average over the previous six months.

“Continually disappointing U.K. data will create more sympathy amongst monetary policy committee members to keep rates lower for longer to help the economy,” said Neil Jones, head of European hedge-fund sales at Mizuho Corporate Bank Ltd. in London.

To contact the reporter on this story: Garth Theunissen in London gtheunissen@bloomberg.net

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

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