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Gilts Fall as Inflation Quickens; Pound Weakens Most in 4 Weeks

June 18 (Bloomberg) -- U.K. government bonds fell for a second day as a government report showed inflation accelerated last month, damping speculation the Bank of England will expand its debt-buying program.

Ten-year gilt yields climbed the most in a week as investors weighed what Federal Reserve Chairman Ben S. Bernanke will say about U.S. asset purchases after the Fed’s Open Market Committee ends a two-day meeting tomorrow. A gauge of the U.K. inflation outlook known as the break-even rate increased for a third day. The pound dropped the most in four weeks against the dollar after rising to the strongest since February yesterday.

“Most people really ought to look through that higher-than-expected number,” said Sam Hill, a fixed-income strategist at Royal Bank of Canada in London. “It’s a little bit of a surprise that yields are up quite as much as they are. This reflects nervousness around the tone the FOMC statement might adopt.”

The benchmark 10-year gilt yield rose six basis points, or 0.06 percentage point, to 2.14 percent at 4:29 p.m. London time, the biggest increase since June 10. The 1.75 percent bond due in September 2022 fell 0.485, or 4.85 pounds per 1,000-pound ($1,561) face amount, to 96.785.

Britain’s annual inflation rate increased to 2.7 percent in May from 2.4 percent in April, the Office for National Statistics said. The median forecast of 36 economists in a Bloomberg News survey was for 2.6 percent. Inflation erodes the value of the fixed payments from bonds.

Inflation Outlook

The 10-year break-even rate, a gauge of inflation expectations derived from the yield difference between regular and index-linked bonds, increased five basis points to 3 percentage points. The rate fell to 2.90 percentage points on June 11, the lowest since Jan. 10.

Economists say reports on June 20 will show U.K. retail sales increased in April, while an industry gauge of manufacturing orders improved in June. Jobless claims fell more than economists forecast in May, the Statistics Office said on June 12.

“We’ve seen data surprises on the upside,” said Nick Stamenkovic, a fixed-income strategist at RIA Capital Markets Ltd. in Edinburgh. “Consequently expectations of further quantitative easing have been pared back significantly and that’s been reflected” in higher gilt yields, he said.

Bernanke Conference

Bernanke will hold a press conference in Washington tomorrow following the central-bank’s policy meeting. He said on May 22 the Fed could reduce its monthly purchases of $45 billion of Treasuries and $40 billion of mortgage-backed securities if the employment outlook shows sustained improvement.

Gilts handed investors a loss of 1.6 percent this year through yesterday, according to Bloomberg World Bond Indexes. German bonds dropped 0.7 percent and Treasuries declined 1.1 percent, the indexes show.

The pound weakened 0.6 percent to $1.5632, the biggest one-day decline since May 22. Sterling climbed to $1.5752 yesterday, the highest since Feb. 11. The U.K. currency fell 0.9 percent to 85.80 pence per euro.

“The pound is not having a good day,” said Neil Jones, head of European hedge-fund sales at Mizuho Corporate Bank Ltd. in London. “I sense it’s probably some profit taking, some shorter term, more nimble investors have got themselves long the pound in recent weeks on the back of improved data.” A long position is a bet an asset will rise.

Sterling has strengthened 3.6 percent in the past three months, according to Bloomberg Correlation-Weighted Indexes that track 10 developed-market currencies. The euro rose 3.7 percent, the best performer, and the dollar fell 0.2 percent.

To contact the reporter on this story: Lukanyo Mnyanda in Edinburgh at lmnyanda@bloomberg.net

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

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