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Gilts Slump for the Week on Inflation Concern; Pound Climbs

U.K. government bonds had their third consecutive weekly decline, lifting ten-year yields to an eight-month high, as faster-than-estimated inflation boosted expectations for interest-rate increases this year.

The pound strengthened against 13 of its 16 most-actively traded counterparts this past week, rallying most against the South African rand and New Zealand dollar. Consumer inflation quickened to 3.7 percent in December, Britain’s statistics office said Jan. 18, faster than the 3.4 percent rate forecast in a Bloomberg survey and up from 3.3 percent in November.

“It seems the market is pricing in a rate hike,” said Chris Walker, a Group-of-10 currency strategist at UBS AG in London. “The feeling is that the Bank of England might think it’s better to nip inflation in the bud rather than risk losing credibility.”

The yield on the 10-year government bond rose 8 basis points for the week to 3.69 percent as of 5:15 p.m. in London yesterday. The 4.75 percent security due March 2020 fell 0.68, or 68 pence per 1,000-pound ($1,600) face amount, to 108.10. Two-year yields were little changed in the week at 1.34 percent.

Inflation in Britain has quickened as the Bank of England slashed its benchmark rate to a record low of 0.5 percent and provided 200 billion pounds of emergency stimulus to help the economy recover from its 2009 recession. Bank of England Governor Mervyn King will need to write a fifth consecutive public letter of explanation if inflation persists above the government’s 3 percent limit in next month’s data.

Pound ‘Rewarded’

The pound strengthened 0.8 percent in the past five days to $1.5994. The British currency lost 0.7 percent in the week to 84.91 pence per euro.

“Sterling is being rewarded as the market prices in higher yields going forward,” said Walker. UBS expects the central bank to lift its main rate by 25 basis points in July, with “the most likely outcome” being a rise to 1 percent by year-end, said Walker.

The Bank of England, which last week left its main rate unchanged, is forecast to raise the benchmark rate to 0.75 percent in the third quarter of this year, according to the median forecast of economists in a Bloomberg survey.

Posen Outlook

Adam Posen, a policymaker at the central bank, today dismissed the recent burst of inflation as temporary, saying price growth will slow to “well below” the bank’s 2 percent target.

Posen’s comments “shouldn’t come as a surprise,” said Nick Stamenkovic, a fixed-income strategist at RIA Capital Markets Ltd. in Edinburgh. “He’s in the minority, and that will be evidenced in the release of the minutes next week.”

Minutes of the bank’s Jan. 13 meeting will be published on Jan. 26.

A jobless report on Jan. 19 had stemmed expectations of higher rates. It showed youth unemployment rose to the highest since at least 1992 and pay growth trailed the inflation rate, even as overall jobless claims fell. A report today showed U.K. retail sales slumped the most on record for a December as the heavy snowfalls deterred Britons from shopping.

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