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Pound Tumbles on Bank of England Inflation Report

The pound fell for a third day against the euro, dropping toward a 15-month low, after Bank of England Governor Mervyn King said U.K. growth is likely to be weak and the economy faces “big challenges.”

Sterling tumbled at least 0.5 percent versus all of its 16 major counterparts as King said at a press conference in London that there were “limits” to what policy makers could achieve. U.K. government bonds fell, with 10-year yields rising by the most in six weeks, as the central bank said inflation will remain above its 2 percent target for the next two years even with weak growth.

“King is saying it’s going to be a rocky road and policy makers will do more if necessary,” said Lee McDarby, head of dealing on the corporate and institutional treasury desk at Investec Bank Plc in London. “People are looking at the gloomy side. So far this year the market has taken any opportunity it can get to sell the pound. There are still a lot of sellers.”

The pound slid 0.7 percent to 86.51 pence per euro as of 4:43 p.m. London time after declining to 87.17 pence on Feb. 1, the weakest level since Oct. 31, 2011. The U.K. currency fell 0.8 percent to $1.5531 after dropping to $1.5505, the lowest level since Aug. 3.

Sterling has tumbled 4.7 percent this year, the second-worst performer after the yen among 10 developed-market currencies tracked by Bloomberg Correlation-Weighted Indexes. It strengthened 2 percent in 2012.

Inflation Outlook

The outlook for consumer prices is higher than was forecast in November because of a weaker pound and increases in energy bills, the Bank of England said in its quarterly Inflation Report released today. The Monetary Policy Committee kept its asset-purchase target at 375 billion pounds and its main interest rate at 0.5 percent when it met on Feb. 7.

“If necessary, we will do more,” King said. “We must recognize, however, that there are limits to what can be achieved via general monetary stimulus -- in any form -- on its own. Monetary policy works, at least in part, by providing incentives to households and businesses to bring forward spending from the future to the present.”

A market gauge of inflation expectations rose toward the highest in almost two years after his comments. The 10-year break-even rate, derived from the difference in yield between nominal and index-linked bonds, widened five basis points to 3.26 percentage points. It expanded to 3.27 on Feb. 5, the most since April 2011.

Deteriorating Outlook

“The MPC seems to be in a wait-and-see mode, waiting to see the effects of the past policy accommodation on the real economy,” Annalisa Piazza, a fixed-income analyst at Newedge Group in London, wrote in a note to clients. “Some more accommodation might be justified should the economic outlook deteriorate sharply.”

The yield on the 10-year gilt climbed 10 basis points, or 0.1 percentage point, to 2.21 percent after rising as much as 14 basis points, the biggest increase since Jan. 2. The 1.75 percent bond due in September 2022 fell 0.88, or 8.80 pounds per 1,000-pound face amount, to 96.08.

Investors should avoid 30-year bonds because their returns aren’t enough to compensate for inflation, according to Pacific Investment Management Co. Inflation erodes the purchasing power of the fixed income from bonds.

“The long end is certainly a sell,” Michael Amey, a money manager at Pimco in London, said in an interview on Bloomberg Television with Francine Lacqua and Guy Johnson. “The front-end is probably OK,” he said, referring to shorter maturities.

The 30-year yield climbed seven basis points to 3.46 percent after rising to 3.49 percent, the highest level since March 16.

Lower Forecasts

The Confederation of British Industry, the U.K.’s biggest business lobby group, today lowered its 2013 growth projection to 1 percent from 1.4 percent and forecast monetary policy will be kept unchanged until near the end of 2014.

The Inflation-Report press conference was the second last for King before he retires at the end of June, when he will be succeeded by Bank of Canada Governor Mark Carney.

U.K. government bonds handed investors a loss of 2.2 percent this year through yesterday, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. German bunds dropped 1.5 percent and Treasuries fell 0.9 percent.

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