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U.K. Gilts Decline on April Inflation Report, Budget Concern

U.K. government bonds declined after a report showed inflation accelerated to a seventeen-month high, prompting Bank of England Governor Mervyn King to write a public letter explaining how prices will be brought under control.

The losses pushed the 10-year yield up for the first time in six days, snapping its longest run of advances since February. Data from the Office for National Statistics showed consumer prices in the year to April rose 3.7 percent from a year earlier, the highest since November 2008. That topped both the 3.5 percent median forecast of 27 economists in a Bloomberg survey and the central bank’s upper target of 3 percent.

“Gilts are weaker after the inflation report,” said Moyeen Islam, a fixed-income strategist at Barclays Capital in London. “They have had a good run, and given the inflation data, it’s an opportunity for some profit-taking.”

The 10-year yield climbed three basis points to 3.76 percent as of 4:10 p.m. in London. The 4.75 percent security due March 2020 lost 0.24, or 2.4 pounds per 1,000-pound ($1,442) face amount, to 108.06. The two-year yield also gained three basis points, reaching 0.92 percent.

Inflation, which erodes the value of bonds’ principal, accelerated from the 3.4 percent gain reported in March. The Bank of England signaled last week that inflation may be peaking and will fall back in 2011 because of slack in the economy.

Emergency Budget

King downplayed the threat of inflation, calling the rise “temporary” in a public letter to Chancellor of the Exchequer George Osborne, who is set to give details of an emergency budget on June 22. “The temporary effects” of factors including the pound’s drop and higher sales tax “are masking the downward pressure on inflation from the substantial margin of spare capacity in the economy,” King wrote in his letter.

Minutes of this month’s Monetary Policy Committee meeting, which concluded May 10, will be published tomorrow. The MPC kept its key interest rate at a record low of 0.5 percent, and left its bond-buying operation on hold at 200 billion pounds. King has refused to rule out further expansion of monetary stimulus.

Prime Minister David Cameron said yesterday that Britain’s public finances were in worse shape than he had expected, helping prompt the pound to sink to the lowest against the dollar in more than a year.

“Gilts are vulnerable to some headline risk in the run-up to the emergency budget,” Islam said. “There’s still concern about the true scale of the deterioration in public finances.”

Gilts returned 3.2 percent this year, compared with gains of 5 percent for German government bonds and 3.3 percent for U.S. Treasuries, according to indexes compiled by Bank of America Corp.’s Merrill Lynch unit.

‘Slight Spike’

Short sterling futures contracts fell as traders trimmed bets the Bank of England will leave its key interest rate at 0.5 percent for an extended period. The implied yield on the contract expiring December 2011 climbed four basis points to 1.87 percent.

“The inflation data was priced in,” said Ian Stannard, senior foreign-exchange strategist at BNP Paribas SA in London. “The market’s fully aware we’ve got this slight spike in inflation coming through over the next month or so, before it starts to come off quite sharply later in the year and remaining below the BOE’s target.”

The pound weakened for a fifth straight day against the dollar, falling 0.3 percent to $1.4428. It dropped to $1.4252 yesterday, the lowest level since March 31, 2009. The pound depreciated 0.1 percent to 85.74 pence per euro.

Investors should buy the euro against the pound, betting the 16-nation currency will appreciate to 88 pence, Standard Bank Plc said today.

Standard Bank advised ending the trade should the euro weaken to 84.35 pence, according to Steven Barrow, head of Group of 10 currency research in London.

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