Pound Strengthens to Two-Week High Versus Euro on Europe Discord

Sept. 24 (Bloomberg) -- The pound rose to a two-week high against the euro as European leaders clashed on banking plans and a report showed German business confidence declined, boosting demand for the relative safety of the U.K. currency.

U.K. government bonds gained after German Chancellor Angela Merkel and French President Francois Hollande disagreed at a meeting on the weekend on a timetable to introduce joint oversight of the region’s banks. Sterling fell versus the dollar before a government report this week forecast to confirm that Britain’s gross domestic product shrank in the second quarter.

While “the U.K. economy has clear problems ahead of it, sterling still naturally reacts as a safe haven” from the euro region, said Simon Derrick, chief currency strategist at Bank of New York Mellon Corp. in London. “The move to a swift resolution of the euro-zone crisis isn’t taking place and from that perspective it is fairly clear to me that you’re going to see sterling continue to benefit against the euro.”

The pound advanced 0.4 percent to 79.68 pence per euro as of 5 p.m. London time after climbing to 79.55 pence, the strongest level since Sept. 7. The U.K. currency weakened 0.2 percent to $1.6198.

Sterling will appreciate through 78 pence per euro by year-end, a level last seen on July 31, Derrick said. The median of 40 estimates in a Bloomberg survey is for the pound to advance to 79 pence.

Merkel, Hollande

Merkel and Hollande, meeting on Sept. 22 to mark Franco-German reconciliation after World War II, failed to mask their differences on a planned banking union meant to contain the debt crisis. “The earlier, the better,” Hollande told reporters near Ludwigsburg, Germany. Merkel said there’s no point doing something fast if it then doesn’t work.

The Ifo Institute in Munich said its business climate index dropped for a fifth month, to 101.4 for September from 102.3 in August. That’s the lowest reading since February 2010.

Sterling was also supported against the euro as Greece and the representatives of the country’s international lenders agreed to take a week-long break from inconclusive talks to craft an 11.5 billion-euro ($14.8 billion) budget-cut package that’s key to receiving aid funds.

The pound has strengthened 2 percent this year, according to Bloomberg Correlation-Weighted Indexes, which track 10 developed-market currencies. The euro tumbled 3 percent and the dollar weakened 2.6 percent.

Economy Shrinks

The U.K. economy shrank 0.5 percent in the three months ended June 30, the Office for National Statistics will say on Sept. 27, according to a Bloomberg News survey. That would match the initial estimate released Aug. 24.

The pound earlier dropped to $1.6182, below its 10-day moving average for the first time since Sept. 5.

The 10-year gilt yield fell two basis points, or 0.02 percentage point, to 1.81 percent after dropping 13 basis points last week. The 1.75 percent bond due in September 2022 gained 0.185, or 1.85 pounds per 1,000-pound face amount, to 99.42.

Gilts returned 2.4 percent this year through Sept. 21, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. German bunds also gained 2.4 percent and U.S. Treasuries rose 1.7 percent.

The U.K. five-year break-even rate, a gauge of investor expectations for the annual rate of inflation, dropped five basis points to 2.22 percentage points. U.K. index-linked securities have made a 3.5 percent loss this year, according to indexes compiled by Bank of America Merrill Lynch.

To contact the reporter on this story: Lucy Meakin in London at lmeakin1@bloomberg.net.

To contact the editor responsible for this story: Paul Dobson at pdobson2@bloomberg.net