Pound Weakens, Gilts Slide as China Optimism Damps Safety Demand

The pound weakened against higher-yielding currencies and gilts dropped as speculation China will take steps to spur economic growth drove stocks higher, damping demand for U.K. assets as a refuge.

Sterling fell the most against the Brazilian real and the New Zealand and Australian dollars among the 16 major currencies. Gilts also dropped for the first time in four days before German Chancellor Angela Merkel meets with International Monetary Fund managing director Christine Lagarde amid optimism officials are taking steps to resolve the region’s crisis. The debt office sold 700 million pounds ($1.08 billion) of inflation-linked bonds at a negative yield.

“Sterling has clearly been benefitting in times of risk aversion,” said Paul Robson, a senior foreign-exchange strategist at Royal Bank of Scotland Group Plc in London. “If people are a little bit more confident about Europe, that probably translates into a weaker” pound, he said.

The pound weakened 0.6 percent to A$1.5002 at 4:08 p.m. London time after dropping to A$1.4946, the lowest level since Aug. 2. Sterling dropped 1.4 percent against the real and slid 0.8 percent versus New Zealand’s currency. It was little changed at 82.51 pence per euro, and gained 0.2 percent to $1.5487.

The 10-year gilt yield climbed seven basis points to 2.07 percent. The 3.75 percent bond due September 2021 dropped 0.625, or 6.25 pounds per 1,000 pound face amount, to 114.62. The two-year rate climbed three basis points to 0.42 percent.

China’s import growth slowed to a two-year low in December, government trade data showed today, increasing speculation on monetary easing.

Merkel, Lagarde

Merkel will meet Lagarde at 8 p.m. in Berlin today, while French President Nicolas Sarkozy will hold talks with Lagarde tomorrow in Paris. Merkel and Sarkozy yesterday outlined the increased pace of their response as the financial crisis that began in Greece in 2009 entered its third year amid concern the future of the single currency itself was in doubt.

Sterling has advanced 2.5 percent in the past six months, the third-best performer after the dollar and the yen, according to Bloomberg Correlation-Weighted Indexes, which track 10 developed-nation currencies. The pound outperformed the euro as concern the debt crisis was deepening stoked demand for U.K. assets as an alternative to European ones.

U.K. Rating

Fitch Ratings will review the U.K. credit grade in the first half of the year as part of its normal oversight process, David Riley, head of the sovereign-debt unit at the company, said today at a conference in London.

“There’s not much room for maneuver in the U.K. public finances,” he said. Fitch has “no plans at this point in time to change the rating,” and France’s rating is at “greater risk” of a downgrade, he said.

Additional Bank of England stimulus may not be enough to revive U.K. economic growth, according to the British Chambers of Commerce.

The group said it forecasts policy makers will increase their target for bond purchases by 50 billion pounds to 325 billion pounds in the first quarter.

“This will not achieve its full potential in supporting growth unless supplemented by the early introduction of a sizable and effective credit-easing program,” Chief Economist David Kern said.

Linker Sale

The Debt Management Office sold index-linked gilts maturing in November 2047 at a real yield, or the yield after accounting for inflation, of minus 0.116 percent.

“We’re probably going to have to get used to auctions with negative real yields,” said Jamie Searle, an interest-rate strategist at Citigroup Inc. in London. “Linkers look pretty good value here relative to nominals” because asset purchases by the Bank of England are driving down rates on conventional gilts relative to inflation-linked debt, he said.

Gilts slipped 0.2 percent this year after returning 17 percent in 2011, according to Bank of America Merrill Lynch indexes. U.K. inflation-linked bonds earned more than 21 percent last year, returning 0.2 percent in 2012, the indexes show.

The Debt Management Office will tomorrow sell as much as 3 billion pounds of 3.75 percent bonds due September 2021. It will auction 3.75 percent gilts maturing in 2052 in the week starting Jan. 23.

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