Pound Falls, Gilts Rise on Concern Osborne’s Cuts Harm Growth

The pound fell and U.K. government bonds rose, sending yields toward the lowest this year, amid concern the government’s austerity drive is damping growth and will compel the central bank to keep interest rates on hold.

Ten-year bonds extended a run of eight straight weekly advances after U.K. Chancellor of the Exchequer George Osborne rejected calls for a “Plan B” to scale back his deficit-reduction plan if the economic recovery stalls. Short-sterling futures yields fell, signaling traders were adding to bets for lower interest rates, as the International Monetary Fund said the government should stick to its deficit plan.

“Some of the data has taken a significant turn for the worse and there’s an emergence of questions on the fiscal tightening,” said John Wraith, a fixed-income strategist at Bank of America’s Merrill Lynch unit in London. “It’s incumbent on the Bank of England to keep rates as low as they can for as long as they can to offset the fiscal tightening.”

Sterling fell 0.4 percent to $1.6366 at 4:32 p.m. in London and depreciated 0.3 percent to 89.33 pence per euro after touching 89.38 pence, its weakest level since May 5.

The yield on the 10-year gilt fell two basis points to 3.27 percent. It reached 3.22 percent on June 3, the lowest since November. The 3.75 percent security maturing in September 2020 rose 0.16, or 1.60 pounds per 1,000-pound ($1,636) face amount, to 103.83.

Yields on five-year notes fell three basis points to 1.87 percent. The rate may continue to fall toward 1.45 percent, near the lowest it reached last year, according to Wraith. “The bull run is obviously fairly strong,” he said.

Osborne Comments

Last week, the pound fell and government bond yields reached the lowest levels this year after manufacturing and services indexes fell more than economists estimated and mortgage approvals dropped to the fewest in four months.

Sterling touched its weakest level on record in Bloomberg Correlation-Weighted Currency Indexes, a measure of 10 developed-market currencies, as Prime Minister David Cameron pushes through the biggest spending cuts since World War II.

Osborne said in an interview with BBC Radio 4’s “Today” show there is flexibility in his program, the economy is creating jobs and investors have concluded the U.K. is a “safe bet” because the coalition has committed to putting the public finances on a sustainable path.

Gilts returned 7.6 percent last year, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. They advanced amid optimism the government would control Britain’s record deficit after the coalition between Cameron’s Conservatives and Nick Clegg’s Liberal Democrats replaced the Labour party after last year’s election.

IMF Outlook

Osborne made his comments today as the IMF said the fiscal consolidation measures remain “essential.” A group of 52 economists wrote to the Observer newspaper yesterday saying government cuts are damaging growth and increasing the deficit by reducing tax income and increasing welfare costs.

Teachers, lecturers and civil servants may be among public-sector employees planning industrial action on June 30, the Daily Telegraph reported.

“There’s no doubt that over time the U.K. needs a credible fiscal consolidation plan, but that doesn’t mean that the pace of the cuts is correct,” Jonathan Portes, a director at the National Institute of Economic and Social Research, told Maryam Nemazee on Bloomberg Television’s “The Pulse.”

Meeting This Week

The pound’s decline “should be helpful for exports, which is part of the growth strategy, which in turn should feed through to stronger investment in job growth,” International Monetary Fund Managing Director John Lipsky said today in an interview with Bloomberg Television’s Linzie Janis in London.

The austerity measures may deter central bank policy makers from raising rates, even though inflation accelerated to 4.5 percent in April, the fastest since 2008. The yield on short-sterling futures for June 2012 fell three basis points to 1.27 percent as investors cut bets on higher borrowing costs.

The Bank of England has kept its main interest rate unchanged at a record-low 0.5 percent since March 2009 and bought 200 billion pounds of bonds under so-called quantitative easing that ended in February 2010. Policy makers will announce their latest decision on June 9. It’s appropriate for the Bank of England to maintain the “current scale of monetary stimulus,” the IMF said.

“With limited room for maneuver on the fiscal side, we believe that monetary policy is more likely to bear the cost of adjustment” should economic risks including a weakening of global growth occur, Goldman Sachs Group Inc. economists Kevin Daly and Adrian Paul wrote in a report dated June 3. “In the extreme, the realization of downside risks could imply a return to quantitative easing in the U.K.”

Commerzbank AG lowered its estimate for the pound to a range between 90 and 91 pence per euro in August, down from 87 pence to 88 pence. It’s “more than likely the Bank of England will be on hold” while the European Central Bank increases borrowing costs, said Peter Kinsella, a currency strategist.

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