The pound weakened and gilts rose amid concern that U.K. economic growth will falter as European leaders struggle to meet a one-week deadline for a plan to stem the euro-region’s debt crisis.
Sterling snapped a three-day gain versus the dollar after Ernst & Young LLP’s ITEM Club cut its U.K. growth forecast and said the Bank of England should lower its main interest rate. The pound reversed an earlier gain after Steffen Seibert, German Chancellor Angela Merkel’s chief spokesman, said European leaders won’t fulfill any “dreams” of a quick end to the euro-area’s debt crisis at their Oct. 23 summit.
“The German politicians have come out and said don’t expect any wonderful plans,” said Derek Halpenny, head of European currency research at Bank of Tokyo-Mitsubishi UFJ Ltd. in London. “That has hit confidence to a degree and the pound has suffered on the top of that.”
The pound weakened 0.3 percent to $1.5778 at 4:30 p.m. London time, paring last week’s 1.7 percent advance. Sterling depreciated 0.9 percent to 121.13 yen, and strengthened 0.6 percent to 87.26 pence per euro.
Group of 20 finance ministers and central bankers concluded weekend talks in Paris endorsing parts of the emerging plan to avoid a Greek default, bolster banks and curb contagion. They set the Oct. 23 summit of European leaders in Brussels as the deadline for it to be delivered.
Merkel has made it clear that “dreams that are taking hold again now that with this package everything will be solved and everything will be over on Monday won’t be able to be fulfilled,” Seibert, Merkel’s chief spokesman, said at a news briefing in Berlin today. Finance Minister Wolfgang Schaeuble said leaders won’t present a “definitive solution” for the crisis at the meeting.
“With the U.K. recovery grinding to a halt, new measures are now needed,” said Peter Spencer, chief economic adviser to the ITEM Club. “We have based our figures on the assumption of an early resolution of the crisis gripping the euro zone, which may prove optimistic in view of the very slow progress made until now. In that case, the outlook for the U.K. would inevitably be a lot worse.”
The 10-year gilt yield slid eight basis points, or 0.08 percentage point, to 2.52 percent, after earlier rising to 2.64 percent. The 3.75 percent security maturing in September 2021 advanced 0.760, or 7.60 pounds per 1,000-pound ($1,577) face amount, to 110.670. The two-year note yield declined three basis points to 0.60 percent.
Gilts have returned 10 percent this year, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies, beating the 5.9 percent return for German bunds and 3.1 percent for French securities. U.K. debt has outperformed as government austerity measures erode growth and the debt crisis roiling European markets drives investors to the perceived safety of the securities.
U.K. gross domestic product will increase 0.9 percent in 2011 and 1.5 percent in 2012, compared with July projections of 1.4 percent and 2.2 percent respectively, the ITEM Club said.
Should euro-region leaders fail to quell the crisis, larger doses of so-called quantitative easing will be insufficient in the U.K. and the government may need to provide additional support such as tax cuts to boost growth, the ITEM research group said.
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“The ITEM downgrade to growth highlights the potential risk of a worsening situation in Europe and how that would impact on the U.K.,” said Halpenny. The forecasts assume a “benign outcome in Europe. If things go pear-shaped, those growth projections tell you that in fact the U.K. would be pretty close to flat growth or even potentially we could envisage an actual contraction.”
The Centre for Economics and Business Research Ltd. lowered its 2011 growth estimate to 0.6 percent from a previous range of between 1 percent and 1.5 percent. It sees the Bank of England raising its bond-program target to 300 billion pounds by the end of 2012, and said a “severe financial crisis” could push it to as high as 400 billion pounds.
The 10-year gilt yield has climbed around 17 basis points since the U.K. central bank announced an extension of its bond-purchase program to 275 billion pounds from 200 billion pounds this month. Minutes of the monetary policy meeting will be published Oct. 19.
“There’s an underlying bid for gilts into higher yields given what the Bank of England is doing,” said Eric Wand, a fixed-income strategist at Lloyds Bank Corporate Markets in London. “There’s still scope for them to do more down the line, so it will be interesting to see what the minutes bring.”